In the long run, a firm chooses a production technique
to minimize the cost of a particular output. By considering each output, it
constructs a total cost curve.
In the long run, a rise in the price of labour (capital)
has a substitution effect and an output effect.
The substitution effect reduces the quantity of labour (capital) demanded
as the capital–labour ratio rises (falls) at each output. But total
costs and marginal costs of output increase. The more elastic the firm’s
demand curve and marginal revenue curve, the more the higher marginal cost
curve reduces output, reducing demand for both factors. For a higher price
of a factor, the substitution and output effects both reduce the quantity
demanded.
In the short run, the firm has fixed factors, and probably
a fixed production technique. The firm can vary short-run
output by varying its variable input, labour, which is subject to diminishing
returns when other factors are fixed. The marginal physical product
of labour falls as more labour is hired.
A profit-maximizing firm produces the output at which marginal output cost
equals marginal output revenue. Equivalently, it hires labour until the marginal
cost of labour equals its marginal revenue product.
One implies the other. If the firm is a price-taker in its output market,
the MRPL is its marginal valueproduct,
the output price times its marginal physical product. If the firm is a price-taker
in the labour market, the marginal cost of labour is the wage rate. A perfectly
competitive firm equates the real wage to the marginal physical product of
labour.
The downward-sloping marginal physical product of labour schedule is the
short-run demand curve for labour (in terms of the real wage)
for a competitive firm. Equivalently, the marginal value product of labour
schedule is the demand curve in terms of the nominal wage. The MVPL schedule
for a firm shift s up if the output price increases, the capital stock increases
or if technical progress makes labour more productive.
The industry’s labour demand curve is not merely
the horizontal sum of firms’ MVPL curves. Higher industry output in
response to a wage reduction also reduces the output price. The industry labour
demand curve is steeper (less elastic) than that of each firm, and more inelastic
the more inelastic is the demand curve for the industry’s output.
Labour demand curves are derived demands. A shift in the
output demand curve for the industry will shift the derived factor demand
curve in the same direction.
For someone already in the labour force, a rise in the hourly real
wage has a substitution effect tending to increase
the supply of hours worked, but an income effect tending
to reduce the supply of hours worked. For men, the two eff ects cancel out
almost exactly in practice but the empirical evidence suggests that the substitution
effect dominates for women. Thus women have a rising labour supply curve;
for men it is almost vertical.
Individuals with non-labour income may prefer not to work. Four things
raise the participation rate in the labour force: higher
real wage rates, lower fixed costs of working, lower non-labour income and
changes in tastes in favour of working. These explain the trend for increasing
labour force participation by married women over the last few decades.
