Changes in Factor Demand and Factor Supply: Study Guide (Microeconomics 5.2)

Movements and shifts

In Topic 5.1 you met the labour market: a downward-sloping demand curve (D_L), an upward-sloping supply curve (S_L), and an equilibrium wage and quantity of labour. This topic asks: what makes those curves move?

The rule is the same as in Unit 2:

• A change in the wage (the price on the vertical axis) causes a movement along a curve. It changes the quantity of labour demanded or supplied.
• A change in anything else that affects hiring or willingness to work shifts the curve. It changes demand or supply itself.

So before you draw anything, ask: is the change in the wage itself, or in something that affects how many workers are wanted (or willing to work) at every wage?

What shifts labour demand

The firm’s demand for labour is its MRP curve, and for a firm that sells at a market price, MRP = MP × P. Anything that changes MP or P at every level of employment shifts the curve. Because labour demand is derived from product demand, many labour demand shifts start in the product market.

Determinant	Change	Effect on labour demand	Why
Price of the output (often from a change in demand for the product)	rises	increases (shifts right)	each worker’s output is worth more: MRP rises at every quantity
Productivity of workers (training, better tools, more capital to work with)	rises	increases	MP rises at every quantity, so MRP rises
Price of an input that substitutes for labour (for example, self-service machines)	falls	usually decreases	firms switch some tasks to the cheaper input
Price of an input used together with labour (a complement)	falls	increases	firms use more of that input and need more workers to operate it
Number of firms hiring this type of labour	rises	market demand increases	more buyers in the labour market

The first two are the ones you must know well; they come straight from MRP = MP × P. The reverse changes shift demand the other way: a fall in the output price or in productivity decreases labour demand.

With supply unchanged, an increase in labour demand raises both the wage and employment (Figure 1). A decrease lowers both.

What shifts labour supply

The supply of labour to a market depends on how many people are able and willing to do that job at each wage. The main determinants are:

Determinant	Example of a change	Effect on labour supply in this market
Immigration	trained workers arrive from abroad	increases
Education and training	more people qualify for the job	increases (a longer or harder qualification would decrease it)
Working conditions	the job becomes safer, more flexible or more pleasant	increases
Age distribution	more people reach working age	increases (more people retiring would decrease it)
Availability of alternative options	wages rise in another job the same people could do	decreases
Preferences for leisure	people come to value free time more	decreases
Cultural expectations	social attitudes change so that more people see the job as a suitable career	increases (attitudes that discourage the job decrease it)

Notice that working conditions are non-wage features of the job. A better wage moves along the supply curve; a better workplace shifts it.

With demand unchanged, a decrease in labour supply raises the wage and lowers employment (Figure 2). An increase in supply lowers the wage and raises employment.

Worked example 1: Brackwater Laundry’s demand for workers

Question. Brackwater Laundry is a fictional laundry with a fixed set of machines. It sells washes in a competitive market at $3 per load and pays a market wage of $90 per day. The marginal product of each worker (loads per day) is:

Worker	1st	2nd	3rd	4th	5th	6th
MP (loads per day)	40	35	30	25	20	15

(a) Calculate each worker’s MRP and the number of workers whose MRP is at least the $90 wage. (b) A new hotel contract raises the market price to $4 per load. Recalculate MRP. How many workers are now worth hiring at $90? (c) Instead (price back at $3), new folding equipment raises every worker’s MP by 20%. Repeat (b). (d) Describe each change on a graph of Brackwater’s demand for labour.

(a) MRP = MP × $3: $120, $105, $90, $75, $60, $45. MRP is at least $90 for the first 3 workers.

(b) MRP = MP × $4: $160, $140, $120, $100, $80, $60. Every worker’s MRP rises by exactly their MP × $1. MRP is at least $90 for the first 4 workers (the 5th adds only $80).

(c) New MP = old MP × 1.2: 48, 42, 36, 30, 24, 18. MRP = MP × $3: $144, $126, $108, $90, $72, $54. Now 4 workers have MRP of at least $90.

(d) In both cases, MRP is higher at every number of workers, so Brackwater’s MRP curve (its demand for labour) shifts right. At the unchanged wage of $90, the quantity of labour demanded rises from 3 to 4. The wage did not change, so this is a shift, not a movement.

Check. The 4th worker’s MRP was $75. It became $100 after the price rise and $90 after the productivity rise: both now cover the $90 wage. If every laundry in the town gained the same contract or equipment, the market demand for laundry workers would also shift right, and the market wage would rise (Figure 1).

Worked example 2: two shifts in Velmora’s market for nurses

Question. Velmora is a fictional country. In its market for nurses, Q is thousands of nurses and W is the wage in dollars per hour:

• Demand: Q_d = 120 − 2W
• Supply: Q_s = 3W − 30

Over five years, two things happen. Velmora’s population ages, so people buy more health care, and demand for nurses rises by 20 thousand at every wage. At the same time, a programme welcomes trained nurses from abroad, and supply rises by 30 thousand at every wage.

(a) Identify the curve each event shifts and explain why. (b) Find the equilibrium wage and employment before and after. (c) Find the result of each shift on its own. Use this to explain why, without numbers, the effect on the wage is indeterminate. (d) How large would the supply increase have needed to be to leave the wage at its original level?

(a) The ageing population raises demand for health care, and demand for nurses is derived from it: labour demand increases. Immigration of trained nurses means more people able and willing to work as nurses at every wage: labour supply increases. (Age distribution is also a supply determinant: if many nurses retired, supply would fall. Here we assume the nursing workforce itself is unchanged, so ageing acts only through demand.)

(b) Before: 120 − 2W = 3W − 30, so 150 = 5W, W = $30, Q = 120 − 60 = 60 thousand. After: demand Q_d = 140 − 2W; supply Q_s = 3W. So 140 − 2W = 3W, 140 = 5W, W = $28, Q = 3 × 28 = 84 thousand.

(c)

Change	New wage	New employment
Demand increase only	140 − 2W = 3W − 30 → $34	72 thousand
Supply increase only	120 − 2W = 3W → $24	72 thousand
Both	$28	84 thousand

Both shifts raise employment, so employment must rise. But the demand shift pushes the wage up and the supply shift pushes it down. Here the supply shift is stronger, so the wage falls by $2. With a smaller wave of immigration, the wage could have risen. Without the sizes of the shifts, the wage change is indeterminate.

(d) After the demand shift, quantity demanded at $30 is 140 − 60 = 80 thousand. Original supply at $30 is 3 × 30 − 30 = 60 thousand. Supply must rise by 20 thousand at every wage for the wage to stay at $30.

Interpretation. Velmora’s nurses gain jobs but not pay, because supply grew faster than demand. Exam answers must say which variable is certain (employment) and which is indeterminate (wage), unless numbers are given.

Two shifts at once: a summary

Labour demand	Labour supply	Wage	Quantity of labour
increases	increases	indeterminate	rises
increases	decreases	rises	indeterminate
decreases	increases	falls	indeterminate
decreases	decreases	indeterminate	falls

Beyond labour

The same logic applies to other factor markets. If the price of rice rises, each hectare of rice land has a higher MRP, so demand for farmland rises and land rents rise. If new route-planning software lets each delivery van make more drops a day, firms’ demand for vans (capital) rises. In each case the factor’s demand is derived from the demand for what it helps to produce.

Common misconceptions

• “A higher wage reduces the demand for labour.” It reduces the quantity demanded: a movement along the curve.
• “A rise in the price of the product increases the supply of labour.” It raises the MRP of workers, so it shifts labour demand. People’s willingness to do the job has not changed.
• “Better working conditions increase labour demand.” Working conditions affect how willing people are to do the job: they shift supply.
• “Higher wages in another job increase supply in this one.” They draw workers away, so supply in this market decreases.
• “Higher productivity always destroys jobs.” In this model, more productive workers have a higher MRP, so labour demand increases. Labour demand falls when a cheaper input replaces workers, which is a different change.
• “When both curves shift, both the wage and quantity change in a known direction.” One of them is indeterminate unless you know the sizes of the shifts (Worked example 2(c)).
• “An increase in labour supply moves the supply curve up.” It moves the curve right: more workers at every wage. The new curve lies to the right of, and below, the old one, so describe it as a shift right, not up.

Where this leads

You can now shift labour demand and supply and predict the new wage and employment. Next, Topic 5.3 shows how a single firm decides exactly how many workers to hire when it takes the market wage as given, using MRP = MRC: see Topic 5.3, Profit-Maximizing Behavior in Perfectly Competitive Factor Markets. Test yourself with the practice questions, then use the revision notes and the checklist. To revise MRP and MRC, return to Topic 5.1, Introduction to Factor Markets.