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Explain how a firm's long run demand for labour is derived

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Introduction

Question 1 a) Explain how a firm's long run demand for labour is derived. (40%) Labour is a derived demand realised by the demand for the product that the labour will be producing. The theory of 'labour demand' explains the behaviour of the firm with the key principle being to achieve the optimal amounts of labour employers will want to utilise at different wage levels. We must make several assumptions when describing how the long run labour demand is derived. Firstly we must assume that firms are profit maximisers and therefore will attempt always to minimise any costs incurred. Further assumptions to simplify analysis of labour demand are that there are no costs of employment other than hourly wages and productivity of labour is independent of time worked. I.e. Labour is homogenous. The production process involves only two inputs, Labour (L) and Capital (K): THE FIRMS' PRODUCTION FUNCTIONS IN THE SHORT AND LONG RUN: qSR = f(K, L) qLR = f(K, L) In the long run, the firms' capital stock is not fixed at any level; K is now changeable as opposed to the short-run where the firm is burdened with a stock of capital that might not be the optimal level under the current market conditions. In the indeterminate 'long run period', the firm will therefore be able to select optimal combinations of its variable stock. ...read more.

Middle

The long run demand curve for labour therefore slopes downwards owing to both the substitution and scale effects. b) Discuss the factors that affect the elasticity of the long run demand curve. (30%) The concept of elasticity is diagrammatically shown by a movement along the labour demand curve. It measures the sensitivity of the quantity of labour demanded to changes in the wage rate. The long run demand has several factors which determine its elasticity. The key features were developed by 19th century economist, Alfred Marshall in Principles of Economics. 1. Elasticity of product demand As labour demand is derived demand, the elasticity of product demand affects the labour demand elasticity. The more elastic product demand is, the greater the elasticity of labour demand will be, cetiris paribus. This can be explained by a fall in the wage rate. If this were to occur, the cost of producing a product declines and so too does the price of the product which in turn stimulates an increase in the quantity demanded. If elasticity of product demand is great, the increase in demand for the product will increase by so much that it would be necessary to increase the quantity of labour demanded to enable the surge in production. This would indicate elastic demand for labour. An inelastic product demand would mean that the increase in product demand would be relatively low as would further labour demand. ...read more.

Conclusion

all sectors) by Andrews and Nickell (1982) emerged with negative wage effects and a typically negative real wage elasticity of about -0.5. Hamenmesh (1976) found that short term (quantified as being one year) manufacturing elasticity of labour demand in the US to be 0.32, keeping the elasticity inelastic end less so than the long(er) term estimates already discussed. For every 10 per cent change in the wage, labour demand would change in the opposite direction by 3.2 percent. It has also been researched that the elasticity for labour demand is higher for teenagers than for adults, and also for production workers than service-sector workers. This might follow that it is higher for low skill-level workers than for high skilled/ academically demanding roles. The significance of the findings that I have summarised on elasticity of labour demand is that public and private policies would be affected according to the change in wage rate due to the trade-off between wage and employment. Elasticity will affect the results of this trade-off. For example, if government implements a rise in the minimum wage, and the elasticity is for labour demand being inelastic (approximately 0.3 as I have summarised), a one percent rise in the wage leads to a 30 per cent drop in employment levels. Private strategies are also affected, as a union's bargaining strategy will be influenced by the elasticity. The more inelastic the employers demand for labour, the stronger the negotiations will be to oppose a wage cut. Unions would be more uncompromising when offered a lower wage. ...read more.

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