CHAPTER 5

The Demand for Labor

I. DERIVED DEMAND FOR LABOR

II. A FIRM'S SHORT-RUN PRODUCTION FUNCTION

A. Total, Marginal, and Average Product
B. Stages of Production
C. Law of Diminishing Marginal Returns
D. Zone of Production

III. SHORT-RUN DEMAND FOR LABOR: THE PERFECTLY COMPETITIVE SELLER

IV. SHORT-RUN DEMAND FOR LABOR: THE IMPERFECTLY COMPETITIVE

SELLER

V. THE LONG-RUN DEMAND FOR LABOR

A. Output Effect
B. Substitution Effect
C. The Combined Effects
D. Other Factors
1. Product Demand
2. Labor-Capital Interactions
3. Technology

VI. THE MARKET DEMAND FOR LABOR

VII. ELASTICITY OF LABOR DEMAND

A. The Elasticity Coefficient
B. The Total Wage Bill Rules
C. Determinants of Elasticity
1. Elasticity of Product Demand
2. Ratio of Labor Costs to Total Costs
3. Substitutability of Other Inputs
4. Supply Elasticity of Other Inputs
D. Estimates of Wage Elasticity
E. Significance of Wage Elasticity
XIII. DETERMINANTS OF DEMAND FOR LABOR
A. Product Demand
B. Productivity
C. Number of Employers
D. Prices of Other Resources
1. Gross Substitutes
2. Cross Complements

IX. REAL-WORLD APPLICATIONS

A. Textile and Apparel Industries
B. Fast-food Workers
C. Personal Computers
D. Minimum Wage
E. Bank Tellers
F. Defense Cutbacks
WORLD OF WORK
1. Comparative Advantage and the Demand for Labor
2. The Rising Demand for Contingent Workers
3. Occupational Employment Trends

GLOBAL PERSPECTIVES
1. Annual Net Employment Change as a Percentage of Total Employment, 1989 – 99
2. Self-Employment as a Percentage of Non-Agricultural Employment, 1998
3. Temporary Employment as a Percentage of Total Employment

APPENDIX: ISOQUANT-ISOCOST ANALYSIS OF THE LONG-RUN DEMAND FOR LABOR

A. Isoquant Curves
1. Downward Slope
2. Convexity to the Origin
3. Higher Output to the Northeast
B. Isocost Curves
C. Least-Cost Combination of Capital and Labor
D. Deriving the Long-run Labor Demand Curve

LEARNING OBJECTIVES

After learning the material in Chapter 5 of Contemporary Labor Economics, the student should be able to:
1. define and use correctly the terms "derived demand", "marginal product", "average
product", "total product", "zone of production", and "elasticity of labor demand"
2. graph and explain the relationships between the total, marginal, and average product curves
3. explain the law of diminishing marginal returns and how it affects labor demand curves
4. derive the marginal revenue product schedule from a firm’s product demand and
marginal product of labor schedules
5. explain why the marginal revenue product of labor is the basis for short-run labor demand
6. contrast the labor demand curves of firms which operate in perfectly
competitive versus imperfectly competitive output markets
7. explain the difference between short-run and long-run labor demand
8. using the concepts "output effect” and "substitution effect,” explain why a firm's
long-run demand for labor is more elastic than its short-run demand
9. distinguish between "substitutes in production" and "gross substitutes"
10. distinguish between "complements in production" and "gross complements"
11. derive the market demand curve for labor, and explain why it is generally more
inelastic than the simple summation of the labor demand curves of all firms in the
market
12. identify and explain the determinants of the elasticity of labor demand
13. identify and explain the determinants of the demand for labor
14. relate the concepts of labor demand to real-world applications
15. (appendix) use isoquant/isocost analysis to determine the combination of input
ANSWERS TO SELECTED END-OF-CHAPTER QUESTIONS

2. In competitive markets, MP > AP implies that labor costs exceed total revenue; the firm should
shut down in the short run.

4. Wage Quantity VMP

$18 0
14 1 $17.00
11 2 13.50
6 3 10.40
2 4 7.00
1 5 4.55

5. a. Demand will shift to the right.

b. Demand will shift to the right.
c. Demand will shift to the left.

10. Total wage bill: at a $6 wage, the total wage bill is $18; at an $11 wage, the total wage bill is $22.
Demand is inelastic, Ed = .68.

(Appendix)
5. Capital increased; the substitution effect (of capital for labor) exceeds the output effect.

6. Unit elastic (the total wage bill is $60 at both wage rates.)

MULTIPLE CHOICE QUESTIONS

Questions 1-6 are based on the short-run production function below.

1. The "zone of production" consists of labor D

Total Product

inputs over the range of:

a. 0X c. 0Y C
TP
b.* YZ d. XZ
B
2. The slope of line segment OD can be
interpreted as the:
a. total product of labor at Y
b.* average product of labor at Y
c. marginal product of labor over the A
range 0Y
d. greatest possible marginal product
of labor
3. The slope of line segment 0D can be interpreted
0
as the: X Y Labor
Z
a.* marginal product of labor at Y
b. total product of labor over the range 0Y
c. marginal product of labor over the range 0Y
d. the greatest possible total product of labor

4. Between X and Y:
a.* the marginal product of labor is falling, but is greater than average product
b. both the marginal product and the average product of labor are falling
c. marginal product is rising and average product is falling
d. both the marginal product and the average product of labor are rising
 5. The "law of diminishing marginal returns" begins to take effect at labor input level:
a. 0 b.* X c. Y d. Z

6. At point C:
a. average product is maximized c.* marginal product is
zero
b. marginal product is maximized d. total product is zero

7. In stage I of the production function, increases in the amount of labor

will: a.* increase the productivity of both capital and labor
b. increase the productivity of capital but not labor
c. increase the productivity of labor but not capital
d. decrease the productivity of both capital and labor

8. Which of the following best describes the “law of diminishing marginal returns”?
a. the marginal product of labor is negative
b. output per worker must eventually fall
c. as more labor is added to a fixed stock of capital, total output must eventually fall
d. * as more labor is added to a fixed stock of capital, labor’s marginal product
must eventually fall

9. Which of the following equalities holds when the profit-maximizing quantity of labor is
employed in the short-run?
a. * MRP = MWC c. MRP = AP
b. MP = wage rate d. MRP = 0

10. The short-run labor demand curve of a competitive firm is:

a. its average revenue product curve
b. * its marginal revenue product curve, provided marginal product is below average product
c. its marginal product curve
d. stage II of the total product curve

11. Value of marginal product (VMP) differs from marginal revenue product (MRP) in that:
a. MRP measures the value society places on the next worker’s output while VMP
measures the value the firm places on the next worker’s output
b. * VMP measures the value society places on the next worker’s output while MRP
measures the value the firm places on the next worker’s output
c. MRP always exceeds VMP
d. VMP always exceeds MRP

Questions 12 – 19 are based on the data in the following table. Assume that the labor market is perfectly competitive.

Labor Output Price (D1) Price (D2)

0 0 $10.00 $10.00
1 15 10.00 9.50
2 29 10.00 9.00
3 42 10.00 8.50
4 54 10.00 7.50
5 65 10.00 6.50
6 75 10.00 5.50
12. Suppose product demand is given by the column labeled D 1. If the wage rate is $100, the firm will
achieve maximum profit by hiring workers.
a. 3 b. 4 c. 5 d.* 6

13. Suppose product demand is given by the column labeled D 1. If the wage rate rises from $100 to
$130, the firm will reduce the quantity of labor employed by unit(s)
a. 0 b. 1 c.* 2 d. 3

14. Suppose product demand is given by the column labeled D 1. If the wage rate is $120, the firm will
achieve maximum profit by hiring _ workers.
a. 3 b.* 4 c. 5 d. 6

15. Suppose product demand is given by the column labeled D 1. The value of the marginal product of
the fourth worker is:
a. $10 b. $54 c.* $120 d. $540

16. Suppose product demand is given by the column labeled D 2. If the wage rate is $100, the firm will
achieve maximum profit by hiring workers
a.* 2 b. 3 c. 4 d. 5

17. Suppose product demand is given by the column labeled D 2. The extra revenue generated by the
fourth worker is:
a. $1 b. $12 c.* $48 d. $405

18. Suppose product demand is given by the column labeled D 2. If the wage rate rises from $100 to
$130, the firm will reduce the quantity of labor employed by unit(s).
a. 0 b.* 1 c. 2 d. 3

19. Compared to D1, a firm facing demand schedule D2 will hire:

a. the same number of workers, since total product is the same in both instances
b.* fewer workers, since product price declines as output increases
c. more workers, since product price declines as output increases
d. more information is required

20. The marginal revenue product schedule:

a. measures the increase in total revenue that results from the production of one more unit
b. measures the decline in product price that a firm must accept in order to sell the
extra output of one more worker
c. is the same whether the firm is selling in a purely competitive or imperfectly
competitive market
d.* is the firm's labor demand schedule, provided the firm is operating in the zone
of production

Questions 21 – 24 are based on the data in the following table. Assume that the labor market is perfectly
competitive.

Labor Output Price

0 0 $2.20
1 15 2.00
2 29 1.80
3 42 1.60
4 54 1.40
5 65 1.20
21. If the wage is $20.00, how many workers will this profit-maximizing firm choose to
employ? a.* 2 b. 3. c. 4 d.
5

22. What are the value of marginal product and the marginal revenue product, respectively, for
the fourth worker?
a. $67.20; $9.60 c.* $12.60; $4.80
b. $12.60; $9;60 d. $67.20; $62.40

23. If the wage is $11.00, how many workers will this profit-maximizing firm choose to
employ? a. 2 b.* 3 c. 4 d.
5

24. Rather than the product demand schedule shown in the table, suppose this firm sold
its output competitively for a price of $2.00. In this case, how many workers will this profit-
maximizing firm choose to employ at a wage of $11.00?
a. 2 b. 3. c. 4 d.* 5

25. "The extra output, measured in dollars, that accrues to society when an additional unit of labor
is employed" best describes:
a. marginal product c.* value of marginal product
b. marginal revenue product d. total revenue product

26. For a firm selling output in an imperfectly competitive market, its labor demand curve will:
a. reflect the value of marginal product schedule, provided the firm is operating in the
zone of production
b. decline solely because of diminishing marginal productivity
c.* decline because of diminishing marginal productivity and because product price
declines as output increases
d. be perfectly elastic if the firm is hiring labor competitively

27. All else equal, the imperfectly competitive seller’s labor demand curve is:
a. greater than that of a perfectly competitive seller
b. more elastic than that of a perfectly competitive seller
c.* less elastic than that of a perfectly competitive seller
d. the same as than that of a perfectly competitive seller

28. "To find the market demand curve for a particular type of labor, simply sum the labor
demand curves of all employers of that type of labor." This statement is:
a. true
b. false—sum the value of marginal product curves for the firms to account for changes
in wage rates as employment increases
c. false—sum the value of marginal product curves for the firms to account for changes
in output price as production increases
d.* false—although the price of output for any individual firm may be constant, this may
not be the case for all firms taken collectively

29. Which of the following best describes the output effect of a wage increase?
a.* The firm's marginal cost increases, the firm desires to produce less output, and
therefore less labor is required
b. The cost of labor is relatively higher causing the firm to use relatively more capital
and less labor
c. The firm’s marginal cost falls, the firm desires to produce more output, and
therefore more labor is required
d. The firm’s labor demand curve becomes more inelastic, causing it to employ less labor
30. Which of the following best describes the substitution effect of a wage increase?
a. The firm's marginal cost increases, the firm desires to produce less output, and
therefore less labor is required
b. * The cost of labor is relatively higher causing the firm to use relatively more
capital and less labor
c. The firm's labor demand curve less elastic, causing it to employ less labor
d. The firm's labor demand curve becomes more inelastic, causing it to employ less labor

31. Which of the following best describes the output effect of a wage decrease?
a. The firm's marginal cost increases, the firm desires to produce less output, and
therefore less labor is required
b. The cost of labor is relatively higher causing the firm to use relatively more
capital and less labor
c. * The firm’s marginal cost falls, the firm desires to produce more output, and
therefore more labor is required
d. The firm’s labor demand curve becomes more inelastic, causing it to employ less labor

32. Which of the following best describes the substitution effect of a wage decrease?
a. The firm's marginal cost decreases, the firm desires to produce less output, and
therefore less labor is required
b. * The cost of labor is relatively lower causing the firm to use relatively more
capital and less labor
c. The firm's labor demand curve less elastic, causing it to employ less labor
d. The firm's labor demand curve becomes more inelastic, causing it to employ less labor

33. The firm’s short-run labor demand curve is typically:

a. * less elastic than its long-run labor demand curve
b. the same as its long-run labor demand curve
c. more elastic than its long-run labor demand curve
d. more elastic than its long-run labor demand curve only if labor and capital are
gross complements

34. Suppose that, as a result of an decrease in the market supply of labor, the wage rate has risen
10%. After adjusting its employment level, a firm find its total wage bill has decreased. This
occurrence indicates that the firm’s labor demand:
a. is inelastic over this range of wages
b. * is elastic over this range of wages
c. is unit elastic over this range of wages
d. was inelastic at the old wage, but is elastic at the new, higher wage

35. Suppose that, as a result of an increase in the market supply of labor, the wage rate has fallen
10%. After adjusting its employment levels, a firm find its total wage bill has decreased.
This occurrence indicates that the firm’s labor demand:
a. * is inelastic over this range of wages
b. is elastic over this range of wages
c. is unit elastic over this range of wages
d. was inelastic at the old wage, but is elastic at the new, higher wage

36. In comparing two otherwise identical industries X and Y, an economist finds that labor
demand is more elastic in industry X. Which of the following would support this finding?
a. Capital and labor are less easily substituted for one another in X than in Y
b. Labor costs as a percentage of total costs are relatively lower in X than in Y
c. * Product demand elasticity is higher in X than in Y
d. Substitute resources have a less elastic supply in X than in Y
37. In comparing two otherwise identical industries X and Y, an economist finds that labor
demand is less elastic in industry X. Which of the following would support this finding?
a. * Capital and labor are less easily substituted for one another in X than in Y
b. Labor costs as a percentage of total costs are relatively higher in X than in Y
c. Product demand elasticity is higher in X than in Y
d. Substitute resources have a more elastic supply in X than in Y

38. Which of the following can be predicted to increase the demand for labor?
a. An increase in the price of a gross complement to labor
b. A decrease in the price of a gross substitute for labor
c. A decrease in the number of firms
d. * An increase in product demand

39. Which of the following can be predicted to increase the demand for
labor? a.* An increase in the price of a gross substitute for labor
b. A decrease in the price of a pure complement in production
c. A decrease in product demand
d. An increase in the price of another resource, provided the output effect
exceeds the substitution effect

40. Assume that skilled labor and energy are substitutes in production. An increase in energy
prices is then predicted to:
a. unambiguously increase the demand for skilled labor
b. unambiguously decrease the demand for skilled labor
b increase the demand for skilled labor if the output effect outweighs the substitution
effect d.* decrease the demand for skilled labor if the output effect outweighs the
substitution effect

41. If energy and unskilled labor are gross complements, an increase in the price of energy will:
a. increase the supply of unskilled labor, decreasing the unskilled wage
b. increase the demand for unskilled labor, raising the unskilled wage
c. * decrease the demand for unskilled labor, decreasing the unskilled wage
d. either increase or decrease the demand for unskilled labor, depending on the
relative strengths of the output effect and the substitution effect

42. Skilled labor will benefit from an increase in the wage rate paid to unskilled
labor if: a.* the substitution effect outweighs the output effect
b. the output effect outweighs the substitution effect
c. the output effect and substitution effect work in opposite directions
d. skilled labor and unskilled labor are gross complements

43. In the textile industry, industrial robots and assembly line workers are gross
substitutes. Accordingly, the drop in the price of robots has:
a. decreased the demand for robots
b. increased the demand for assembly line workers
c. * decreased the demand for assembly line workers
d. increased assembly line workers’ wages

44. (World of Work 5-1) International trade:

a. * increases labor demand in some industries, reduces it in others
b. reduces the overall demand for labor
c. increases the overall demand for labor
d. has no impact on labor demand at all
45. (World of Work 5-2) The contingent work force:
a. has grown by approximately 10% over the last two decades
b. includes only temporary workers
c.* includes only workers who are involuntarily employed part-time
d. has shrunk relative to the "core" labor force

46. (World of Work 5-3) In which industries does the Bureau of Labor Statistics project the
fastest employment growth over the next ten years?
a. Real estate and finance
b. Fast food preparation and legal services
c. Maintenance and law enforcement
d.* Computers and health care

47. (appendix) An isoquant shows all combinations of:

a. wage rates and per unit costs of capital that yield the same total profit
b. labor and capital that yield the same total profit
c. labor and capital that yield the same total cost
d.* labor and capital that yield the same total output
48. (appendix) At the least-cost combination of capital and labor:
a.* the marginal rate of technical substitution of labor for capital equals the ratio of the
price of labor to the price of capital
b. the isocost line cuts the isoquant at its lowest point
c. the capital-labor ratio is equal to the ratio of the price of labor to the price of capital
d. is isoquant cuts the isocost line at its lowest point
49. (appendix) The slope of an isoquant reflects the:
a. elasticity of demand for labor
b. isocost line
c. price of capital relative to labor
d.* marginal rate of technical substitution

50. (appendix) If the marginal rate of technical substitution of labor for capital is greater than the
price of labor relative to capital, then the firm can produce the same level of output at lower total cost by
using:
a. more capital and less labor c. more capital and more labor
b.* less capital and more labor d. less capital and less

labor Questions 51 and 52 refer to the following graph:

51. (appendix) If the two isoquants represent profit

Capital

maximizing levels of output for two different wage rates,

the move from point A to point B represents the:
a. output effect of a reduction in the wage
b. output effect of an increase in the wage A
c.* substitution effect of a reduction in the wage
d. substitution effect of an increase in the wage C
B
52. (appendix) If the two isoquants represent profit
maximizing levels of output for two different wage rates,
the output effect of a decrease in the wage rate is
represented by the move from:
a. A to B Labor
b.* B to C c. A to C
d. C to A