causes of shifts in and movement along the demand curve for labour in a firm or an occupation

Labour‑Market Forces – Demand, Supply and Government Intervention

Learning objective

Explain the causes of movements along and shifts of the demand curve for labour in a firm or an occupation, and evaluate how government action can affect labour‑market outcomes (Cambridge 9708 8.3).

1. Derived demand for labour

• Firms do not demand labour for its own sake; they demand it because it helps produce a good or service that is itself demanded.
• The value of an additional worker is the marginal revenue product of labour (MRP_L):

  $$\text{MRP}_{L}= \underbrace{P}_{\text{price of output (or MR if the firm has market power}} \times \underbrace{MP_{L}}_{\text{marginal product of labour}}$$

• Numeric illustration: a car‑manufacturing plant sells each car for £20 000 (P). The extra worker produces 0.3 cars per hour (MP_L). $$\text{MRP}_{L}=£20\,000 \times 0.3 = £6\,000$$ The firm will be willing to pay up to £6 000 for that worker’s hour of labour.
• If the output market is perfectly competitive, P is the market price; if the firm has market power, P is replaced by marginal revenue (MR).
• Because MRP_L depends on product‑market conditions, labour demand is derived.

2. The labour‑demand curve

• Plot wage (w) on the vertical axis and quantity of labour (L) on the horizontal axis.
• At each point on the curve the firm is willing to hire the amount of labour for which MRP_L = w. This set of points is the labour‑demand curve.
• The curve slopes downwards because, ceteris paribus, a higher wage makes the cost of an extra worker exceed its marginal revenue product.

3. Movements along the demand curve

A movement occurs **only** when the wage rate changes while every other determinant of labour demand is held constant.

• Higher wage → lower quantity of labour demanded (movement up the curve).
• Lower wage → higher quantity of labour demanded (movement down the curve).

Elasticity of labour demand with respect to wages:

$$\varepsilon_{L,w}= \frac{\%\Delta L}{\%\Delta w}$$

Figure 1 (a) shows a movement along the demand curve when the wage changes; (b) shows a parallel shift of the whole curve.

4. Determinants that shift the labour‑demand curve (shift factors)

A shift means that at **every** wage level the quantity of labour demanded changes. All shift factors operate by altering the marginal revenue product of labour at the margin.

4.1 Product‑market conditions

• Change in the price of the product (P) – higher P raises MRP_L → rightward shift; lower P lowers MRP_L → leftward shift.
• Change in the quantity demanded for the product (consumer tastes, income, population) – higher expected sales increase marginal revenue per worker → right shift.
• Expectations about future demand – optimistic forecasts lead firms to expand capacity now, shifting demand right.

4.2 Technological change

• Labour‑intensive (or labour‑augmenting) technology – raises MP_L → rightward shift.
• Capital‑intensive (automation) technology – substitutes labour, reducing MP_L → leftward shift.

4.3 Prices of complementary inputs

• Cheaper capital, raw materials or energy lower total production cost, making it profitable to employ more labour → right shift.
• Higher input prices raise total cost, reducing the optimal labour level → left shift.

4.4 Size of the product market / number of firms

• Entry of new firms or expansion of existing firms increases total output, raising aggregate labour demand → right shift.
• Exit or contraction reduces labour demand → left shift.

4.5 Government policy and related factors

• Taxes on labour (pay‑roll tax, employer National Insurance) increase the effective cost of hiring → left shift.
• Wage subsidies, tax credits or training grants reduce the effective cost of labour → right shift.
• Regulations that affect production processes (health‑and‑safety, environmental standards) may force firms to adopt new technology; the direction of the shift depends on whether the new technology is labour‑intensive or labour‑saving.
• Changes in the price of other factors of production (e.g., a rise in the rental price of machinery) make labour relatively cheaper or more expensive, shifting the curve accordingly.

4.6 Summary table of shift factors

Determinant (shift factor)	Direction of shift	Reason (effect on MRPL)	Typical example
Increase in product price	Right	Higher revenue per unit → higher MRPL	Oil price rise raises revenue for refinery workers
Decrease in product price	Left	Lower revenue per unit → lower MRPL	Smart‑phone price fall reduces demand for assembly‑line workers
Higher expected product demand	Right	Firms expand capacity, raising marginal revenue per worker	Anticipated rise in holiday travel boosts airline staffing
Labour‑intensive technological improvement	Right	Increases MPL	Collaborative robots that work alongside humans
Automation (capital‑intensive tech)	Left	Reduces MPL (substitutes labour)	Self‑checkout machines in supermarkets
Fall in price of complementary inputs	Right	Lower total cost → more profitable to hire workers	Cheaper electricity for textile factories
Rise in price of complementary inputs	Left	Higher production cost reduces optimal labour	Higher steel prices for car manufacturers
Market expansion (more firms / larger market)	Right	Total output rises → aggregate labour demand rises	Entry of new streaming services increases demand for content creators
Payroll tax increase	Left	Effective wage paid by firm rises → lower MRPL relative to cost	Higher National Insurance contributions in the UK
Training subsidy to firms	Right	Reduces effective cost of employing workers	Apprenticeship grant for engineering firms

5. Diagrammatic illustration

Figure 1 – (a) movement along the labour‑demand curve caused by a change in the wage rate; (b) a rightward shift of the demand curve after an increase in product price or expected demand. Axes: wage (w) on the vertical axis, quantity of labour (L) on the horizontal axis.

6. Labour supply

• Derived from workers’ trade‑off between leisure and income; represented by an upward‑sloping curve in (w, L) space.
• Key determinants (shift factors for supply):
  • Population size and demographic structure.
  • Alternative earnings (self‑employment, overseas work).
  • Preferences for leisure versus work (cultural attitudes).
  • Education, training and skill levels.
  • Taxes on labour income and welfare benefits (substitution vs. income effects).

7. Wage determination in a perfectly competitive labour market

1. Equilibrium where the labour‑demand curve (MRP_L = w) intersects the labour‑supply curve.
2. At the equilibrium wage (w*), the quantity of labour firms wish to hire equals the quantity workers wish to supply (L*).
3. If either curve shifts, the new equilibrium wage and employment level are found by the same intersection method.

8. Imperfectly competitive labour markets

8.1 Monopsony

• Single (or few) large employer(s) facing an upward‑sloping labour‑supply curve.
• Marginal factor cost (MFC) exceeds the wage paid because hiring an extra worker requires raising the wage for all existing workers.
• Profit‑maximising condition: MRP_L = MFC, leading to a lower wage and lower employment than in a competitive market.

8.2 Trade unions / collective bargaining

• Unions can negotiate a wage above the competitive equilibrium.
• If the negotiated wage exceeds the MRP_L at the competitive employment level, firms hire fewer workers → possible unemployment.

9. Government intervention – impact and evaluation

9.1 Minimum wage

• Sets a legal floor above the equilibrium wage.
• Effect on the demand side: a higher statutory wage is a movement up the existing demand curve and, because the cost of labour rises, the *effective* demand curve shifts leftward.
• Potential outcomes:
  • Positive: higher earnings for workers who remain employed; reduction in in‑work poverty.
  • Negative: unemployment or reduced hours for low‑skill workers if the floor is above the market‑clearing wage.

9.2 Wage subsidies / training grants

• Reduce the effective cost of labour to the firm (e.g., a £2 000 grant per new apprentice).
• Shift the labour‑demand curve rightward, raising both employment and the equilibrium wage (provided the supply curve is upward sloping).
• Evaluation: can correct market failures such as skill shortages, but are costly to the Treasury and may create dependency if not time‑limited.

9.3 Payroll taxes

• Increase the cost of employing labour → leftward shift of the demand curve.
• Result: lower employment and, depending on the incidence, potentially lower take‑home wages.
• Evaluation: raises revenue for public services but can discourage hiring, especially of marginal workers.

9.4 Regulations affecting production processes

• Health‑and‑safety, environmental or quality standards may force firms to adopt new technology.
• Outcome depends on the factor‑intensity of the required technology:
  • Labour‑intensive compliance → rightward shift.
  • Capital‑intensive compliance → leftward shift.
• Evaluation: must balance social benefits (safer workplaces, cleaner environment) against possible job losses.

10. Quick revision checklist

• Labour demand = MRP_L = P × MP_L (or MR × MP_L for imperfectly competitive output markets).
• Movement along the demand curve ↔ change in wage only.
• Shifts ↔ any change in product price, product demand, expectations, technology, input prices, market size, or government policy (all affect MRP_L at the margin).
• Rightward shift → higher equilibrium wage **and** higher employment (ceteris paribus); leftward shift → lower equilibrium wage **and** lower employment.
• Competitive equilibrium: labour demand = labour supply.
• Monopsony → wage below competitive level, employment below competitive level.
• Minimum wage above equilibrium → higher wage, possible unemployment.
• Subsidies → rightward demand shift, higher employment.

11. Key take‑aways

1. Labour demand is a derived demand; it depends on the marginal revenue product of labour.
2. Only a change in the wage rate causes movements along the demand curve; all other factors cause shifts.
3. Identifying the direction of each shift factor allows you to predict the impact of policy measures on wages and employment.
4. Evaluating government intervention requires weighing efficiency effects (changes in employment and output) against distributional and fiscal considerations.