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Demand for Labour

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Economics

Why do we also refer to labour demand as ‘derived demand’? What are the factors that affect the demand for labour? What is the marginal productivity of labour? In this explanation, we will answer these and other questions regarding the demand for labour.

What is the demand for labour?

The concept of labour market can be viewed as a ‘factor market.’ Factor markets provide a way for firms and employers to find the employees they need.

The demand for labour shows how many workers the firms are willing and able to hire at a given time and wage rate.

Therefore, demand for labour is a concept that illustrates the amount of labour a firm is willing to employ at a particular wage rate. However, the determination of equilibrium in the labour market will also depend on the supply of labour.

Equilibrium in the labour market depends on the wage rate firms are willing to pay and the amount of labour willing to provide the necessary work.

Demand for labour curve

As we said, the demand for labour shows how many workers an employer is willing and able to hire at a given wage rate at any given time.

The labour demand curve shows an inverse relationship between the employment level and the wage rate as you can see in Figure 1.

Demand for Labour Labour demand curve StudySmarterFigure 1. The labour demand curve -StudySmarter Originals.

Figure 1 illustrates that if the wage rate decreased from W1 to W2 we would see an increase in employment level from E1 to E2. This is because it would cost less for a firm to hire more workers to produce its output. Thus, the firm would hire more, thereby increasing employment.

Conversely, if the wage rate increased from W1 to W3, employment levels would fall from E1 to E3. This is because it would cost more for a firm to hire new workers to produce its output. Thus, the firm would hire less, thereby decreasing employment.


When wages are lower, labour becomes relatively cheaper than capital. We can say that when the wage rate starts decreasing, a substitution effect might occur (from capital to more labour) that would lead to more labour being employed.

Demand for labour as a derived demand

We can illustrate derived demand with a couple of examples that include the factors of production.

Remember: the factors of production are the resources used to produce goods and services. They include land, labour, capital, and technology.

The demand for reinforcement bars is high due to their frequent use in the construction industry. Reinforcement bars are often made of steel; thus, high demand for these would also correspond to high demand for steel. In this case, steel demand is derived from the demand for the reinforcement bars.

Assume (without considering the effects of COVID-19) that there is an increased demand for air travel. This will inevitably lead to an increase in demand for airline pilots since airlines will need more of them to supply the growing demand for air travel. The airline pilots’ demand in this scenario will be derived from the demand for air travel.

Derived demand is the demand for a factor of production that results from the demand for another intermediate good. In the case of labour demand, it is derived from the demand for a product or a service that labour produces.

A firm will demand further labour only if an increase in the labour force will guarantee to bring in more profits. Essentially, if the demand for a firm’s product increases, the firm will demand more labour to sell the additional units of goods or services. The assumption here is that the markets will demand the goods produced by labour, which in turn will be employed by firms.

Factors affecting the demand for labour

Many factors that can affect the demand for labour.

Labour productivity

If labour productivity increases, firms will demand more labour at each wage rate and the firm’s demand for labour itself will increase. This would shift the labour demand curve outwards.

Changes in technology

Changes in technology can cause the demand for labour to increase and decrease depending on the situation.

If technological changes make labour more productive relative to the other factors of production (such as capital), firms would demand an increased amount of workers and substitute the other factors of production with new labour.

For example, the production of computer chips will require a certain amount of skilled software and hardware engineers. Thus, the demand for such workers would increase. This would shift the labour demand curve outwards.

However, with the production and subsequent competition from other firms, we could assume that chip development could become automated. The subsequent result would be a replacement of labour with machines. This would shift the labour demand curve inwards.

Changes in the number of firms

Changes in the number of firms operating in the industry can have an immense effect on the overall labour market. This is because demand for a certain factor can be determined by the number of firms currently utilising that factor.

For example, if the number of restaurants increases in a certain area, the demand for new waiters, waitresses, cooks, and other forms of gastronomy workers will increase. An increase in the number of firms would result in an outward shift in the labour demand curve.

Changes in demand for a product that labour produces

If there is an increase in demand for new vehicles, we would likely see an increase in demand for raw materials used in vehicle production. This would lead to an increase in demand for workers, as firms would need people to manufacture the vehicles. This would shift the labour demand curve outwards.

Profitability of firms

If a firm’s profitability increases, it will be able to hire more workers. This will lead to an increase in the demand for labour. Conversely, a firm that is making no profit and is consistently registering losses will need to layoff workers as it will not be able to pay them anymore. This would subsequently reduce the demand for labour and shift the demand curve of labour inwards.

The marginal productivity theory of demand for labour

The marginal productivity theory of demand for labour states that firms or employers will hire workers of a particular type until the contribution made by the marginal worker is equal to the cost incurred by having hired this new worker.

We have to assume that this theory is applied to wages in this context. The wage rate is determined through the forces of demand and supply in the labour market. These market forces ensure that the wage rate is equal to that of the marginal product of labour.

However, the theory of diminishing marginal returns assumes that the marginal worker provides less contribution to the work than that of their predecessor. The theory assumes that the workers are relatively the same, meaning they are interchangeable. Based on this assumption, many workers that are hired receive the same wage rate. However, if the firm were to hire workers based on the marginal productivity theory, the firm would then maximise its profits. This can only happen if the hired marginal workers contribute more in value than the costs incurred by the firm.

The determinants of the elasticity of demand for labour

The elasticity of demand for labour measures labour demand’s responsiveness to a change in the wage rate.

There are four main determinants of the elasticity of demand for labour:

  1. The availability of substitutes.
  2. The elasticity of demand for the products.
  3. The proportion of labour cost.
  4. The elasticity of supply of substitutes inputs.

To learn more about the effects of labour demand elasticity check out our explanation Elasticity of demand for labour.

What is the difference between demand and supply of labour?

We have already established that the demand for labour shows how many workers an employer is willing and able to hire at a given wage rate and at a given time period.

While the demand for labour determines how many workers an employer is willing and able to hire at a given time and wage rate, the supply of labour refers to the number of hours a worker is willing and able to work in a given period. It doesn’t refer to the number of workers. A typical supply of labour curve would show how much labour a particular worker plans to supply at different wage rates.

To learn more about the effects of labour supply check out our explanation on Supply for labour.

Demand for Labour - Key takeaways

  • The concept of the labour market can be viewed as a "factor market".
  • The demand for labour shows how many workers the firms are willing and able to hire at a given wage rate at a given time.
  • Labour demand is derived from the demand for a product or a service that labour produces.
  • Labour demand curve shows an inverse relationship between the employment level and the wage rate
  • The factors that affect the demand for labour are:
    • labor productivity
    • changes in technology
    • changes in the number of firms
    • changes in demand for a firm's product

    • firm profitability

  • The marginal productivity theory of demand for labor states that firms or employers will hire workers of a particular type until the contribution made by the marginal worker is equal to the cost incurred by having hired this new worker.

  • The supply of labor mainly refers to the number of hours a worker is willing and able to work in a given period.

Demand for Labour

  • Labour productivity
  • Changes in technology
  • Changes in the number of firms
  • Changes in the demand for a product that labour produces

Negative discrimination towards employees (whether social or economic) leads to the employee perceiving the work as downgrading. This could lead to a loss in value for the firm from the perspective of the employee. This will lead to a reduction in the labour’s marginal revenue product and a decrease in the demand for labour.

The demand for labour essentially shows how many workers the firms are willing and able to hire at a given wage rate at a given time. 

Derived demand is the demand for a factor of production that results from the demand for another intermediate good. In the case of labour demand it is derived from the demand for a product or a service that labour produces.

  • Labour productivity
  • Changes in technology
  • Changes in the number of firms
  • Changes in demand for a firm's product
  • Firm profitability

Final Demand for Labour Quiz

Question

What are the five factors that can influence demand for labour?

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Answer

  • Changes in technology
  • Labour productivity
  • Changes in demand 
  • Changes in the number of firms 
  • Profitability of a firm

Show question

Question

What are the factor markets?

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Answer

The factor markets provide a way for firms or other forms of employers to help find the employees they need.

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Question

What does the demand for labour illustrate?

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Answer

The demand for labour shows how many workers the firms are willing and able to hire at a given wage rate at a given time.


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Question

What is derived demand?

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Answer

Derived demand is the demand for a factor of production that results from the demand for another intermediate good. In case of labour demand, it is derived from the demand for a product or a service that labour produces.


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Question

What is the supply of labour?

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Answer

The supply of labour refers to the number of hours a worker is willing and able to work in a given period.

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Question

What is the elasticity of demand for labour?

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Answer

The elasticity of demand for labour measures the responsiveness of labour demand to a change in the wage rate. 

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Question

What are the four determinants of the elasticity of demand for labour?

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Answer

  1. The availability of substitutes.
  2. The elasticity of demand for the products. 
  3. The proportion of labour cost.
  4. The elasticity of supply of substitutes inputs. 

Show question

Question

What is the difference between the supply of labour and the demand for labour?

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Answer

  • The demand for labour shows how many workers an employer is willing and able to hire at a given wage rate and a given period.
  • The supply of labour refers to the number of hours a worker is willing and able to work in a given period.

Show question

Question

What is the marginal productivity theory of demand for labour?

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Answer

The marginal productivity theory of demand for labour states that firms or employers of a particular business will hire workers of a special kind until the contribution made by the previous marginal worker is equal to the cost incurred by having hired the new worker.

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Question

What factors could shift the the labour demand curve?

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Answer

  • Labour productivity
  • Changes in technology
  • Changes in the number of firms
  • Changes in demand for that product
  • Profitability of firms

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Question

How could profitability of the firm lead to an increase in labour demand?

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Answer

If there is an increase in the marginal revenue of a firm, then it would lead to an increase in the demand for labour.

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Question

How could changes in technology lead to a change in the demand curve?

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Answer

If technological changes make labour more productive relative to the factors of production utilised such as capital, then firms would demand an increased amount of workers and substitute the other factors of production with new labour. This would shift the curve to the right. 

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Question

How can the presence of a larger number of firms influence the demand for labour curve?

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Answer

If there is greater presence of firms in the market, there would be an increase in demand for workers.
This would lead to a shift in the labour demand curve to the right.

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Question

The demand for a factor of production that results from the demand for another intermediate good is called ___________

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Answer

derived demand

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Question

Demand for labour is a derived demand.

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Answer

True

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Question

When the wage rate starts decreasing, a substitution effect might occur that would lead to more labour being employed. What is the substitution in this case?


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Answer

the substitution from capital to more labour 

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Question

The difference between the demand for labour curve and the market wage gives us the ___________


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Answer

worker surplus

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Question

In a perfectly competitive labour market, the competitive wage rate is determined by 


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Answer

 the industry  

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Question

The elasticity of demand for labour measures labour demand’s responsiveness to a change in the ___________.  

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Answer

wage rate 

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Question

The marginal productivity theory of demand for labour states that firms or employers will hire workers of a particular type until the contribution made by the marginal worker is ___________ to the cost incurred by having hired this new worker.  


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Answer

equal  

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Question

If a firm’s profitability increases, it is likely to hire more workers. 

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Answer

True

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Question

A replacement of labour with machines would shift the labour demand curve ___________

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Answer

inwards 

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Question

If labour productivity ___________, firms will demand more labour at each wage rate and the firm’s demand for labour itself will increase. 

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Answer

increases 

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Question

Labour demand curve shows an ___________  relationship between the employment level and the wage rate

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Answer

inverse 

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