Short on time? This page is the recap. For explanations, graphs and worked examples, use the full study guide.
Recap
- A perfectly competitive labour market has many employers, many workers with the same skills, good information and free movement between jobs.
- Market supply and demand for labour set the wage. Each firm is a wage taker: it can hire any number of workers at that wage.
- For the firm, MRC = W at every quantity, so its labour supply curve is horizontal at the market wage.
- The firm hires workers while MRP > W and stops where MRP = MRC = W. Its downward-sloping MRP curve is its labour demand curve.
- A firm can be a monopoly in its output market and still a wage taker in its labour market.
- With other inputs, the firm also uses the least-cost and profit-maximising rules below.
Key relationships
| Relationship | How to use it |
|---|---|
| MRP = ΔTR ÷ ΔL = MP × MR | Revenue added by one more worker, in dollars |
| VMP = MP × P | Equals MRP only if the output market is perfectly competitive (MR = P) |
| Output market power: MR < P | So MRP < VMP; use MRP to decide |
| Wage taker: MRC = W | Constant, however many are hired |
| Hiring rule: MRP = MRC = W | Hire the last worker whose MRP ≥ W (on the falling part of MRP) |
| Least cost: MP_L ÷ W = MP_K ÷ r | If MP_L ÷ W is larger, shift spending to labour |
| Profit maximum: MRP_L ÷ W = MRP_K ÷ r = 1 | Implies least cost; least cost does not imply profit maximum |
| Change | Effect for one firm |
|---|---|
| Market wage falls | Movement down along MRP: more workers hired |
| Market wage rises | Movement up along MRP: fewer workers hired |
| Output price or productivity changes | MRP curve shifts (Topic 5.2) |
Assumptions
- Other inputs are fixed when we study the labour decision on its own.
- Workers are identical, so one wage applies to all.
Mistakes to avoid
- Comparing MP (units of output) with the wage (dollars).
- Using VMP for a firm that has to cut its price to sell more.
- Drawing the firm’s labour supply as upward-sloping, or as the market supply curve.
- Stopping where MP peaks, or where total revenue is largest.
- Calling equal MP-per-dollar ratios “profit maximising” when MRP is still above the input price.
- Treating a wage change as a shift of labour demand.
Quick self-check
- A worker adds 12 units of output that sell for $5 each in a competitive market. The wage is $50. Should the firm hire them? (Yes: MRP = 12 × 5 = $60 > $50.)
- MP_L = 10, W = $20, MP_K = 30, r = $40. To cut costs, which input should the firm use more of? (Capital: 30 ÷ 40 = 0.75 per dollar is more than 10 ÷ 20 = 0.5.)
- Why is a wage taker’s MRC equal to the wage? (It can hire another worker at the market wage without raising pay for anyone.)
Next: practice questions.