OCR A Level Economics: Demand for labour, productivity and unit labour costs (H460) – Revision Notes

These notes condense the demand side of the topic Wage determination from the OCR A Level Economics (H460) specification, in Component 1, Microeconomics. The specification labels no content as AS or Extension. Full explanations are in the study guide. Test yourself with the practice set, the OCR Economics hub, the checklist and the free diagnostics. All figures are invented and illustrative.

Definitions

Term	Meaning
Derived demand	Demand for labour that arises from demand for the output it produces
Sub-markets for labour	Separate markets by occupation, skill, industry, region, sector or contract type
Nominal (money) wage	Pay in current prices
Real wage	Pay adjusted for price changes; what it can buy
Wage elasticity of demand (WED)	Responsiveness of quantity of labour demanded to the wage
Productivity	Output yielded by each unit of input; for labour, per worker or per hour worked
Unit labour cost (ULC)	Labour cost per unit of output
Human capital	Skills, knowledge, qualifications and health embodied in workers
MPP	Output added by one further worker
MRP	Revenue added by one further worker

Formulas

Measure	Formula
Real wage	(nominal wage ÷ price index) × 100
WED	% change in labour demanded ÷ % change in wage rate
Labour productivity	Total output ÷ workers (or hours)
ULC	Total labour cost ÷ output = wage ÷ output per hour
ULC index	(wage index ÷ productivity index) × 100
MRP	MPP × marginal revenue (= price if the product market is perfectly competitive)

Derived demand and sub-markets

Firms hire for the output labour produces, so the demand for labour moves with demand for the product. If demand for a good rises, the revenue from each worker rises and the firm wants more workers at each wage. Labour is not one market. Sub-markets differ by occupation, skill, industry, region, sector and contract type, and moving between them takes time, training or relocation. That is why vacancies and unemployment can exist together.

Method in steps: converting to real terms

1. Pick the base year (index 100).
2. Divide the nominal wage by the price index and multiply by 100.
3. Compare real values, or work out the percentage change.

Reminder: wages up 2% while prices rise 3% gives 1.02 ÷ 1.03 - 1 = -0.97%. Real pay fell, although nominal pay rose.

Method in steps: WED

1. Find the percentage change in the wage.
2. Find the percentage change in employment.
3. Divide the second by the first and keep the sign.
4. Size above 1 is elastic; below 1 is inelastic.
5. Link to the wage bill: elastic means a wage rise cuts the bill; inelastic means it rises.

Reminder: a 5% wage rise with WED of -2 cuts employment by 10%.

Factors to remember

Demand for labour shifts with	WED is lower when
Demand for the product (derived)	Few substitutes for labour
Productivity of workers	Labour is a small share of costs
Price of the product	Product demand is inelastic
Price and productivity of capital	The time period is short
Non-wage labour costs
Technology, expectations, policy

A change in the wage is a movement along the demand curve. Anything else is a shift.

Productivity and ULC

Method for ULC: find total labour cost, find total output, divide. Or divide the hourly wage by output per hour.

Reminder: a firm pays £9,000 in wages for 4,500 units: ULC = £2.00. If output rises to 6,000 with the same bill, ULC = 9,000 ÷ 6,000 = £1.50.

Rules of thumb:

• ULC rises if wages grow faster than productivity.
• ULC index: wages 112, productivity 120 gives 112 ÷ 120 × 100 = 93.33. ULC fell 6.67%.
• A wage rise of 4% with productivity up 10% gives 1.04 ÷ 1.10 - 1 = -5.45%.
• Comparing countries needs a common currency, so the exchange rate affects the comparison.

Evaluating variations between firms and countries. Low ULC can help price competitiveness, exports, profit and investment. Weigh it against: the source (low pay or high productivity), non-price competitiveness, exchange rates, the use of national averages and the time period.

Evaluating the impact on firms. Judge by labour’s share of costs, the ability to pass costs on, whether productivity responds, the time period, and whether the change is in wages or in ULC.

Human capital

Raised by education, training and experience. It lifts productivity, lowers ULC and raises MRP. Training costs are paid now and the return comes later, so a firm weighs the payback. A firm may under-invest if trained workers can leave for rivals.

Worked reminder. Training costs £900 per worker and raises output by 0.3 units an hour. The worker does 1,200 hours a year and each extra unit adds £2 net revenue.

extra output = 0.3 × 1,200 = 360 units
extra net revenue = 360 × 2 = £720 a year
payback = 900 ÷ 720 × 12 = 15 months

Wage rises and the firm: worked reminder

Labour is £120,000 of a firm’s £400,000 total costs (30%). Wages rise 6%.

extra cost = 120,000 × 0.06 = £7,200  (1.8% of total costs)
productivity +6%: ULC change = 1.06 ÷ 1.06 - 1 = 0%
productivity +3%: ULC change = 1.06 ÷ 1.03 - 1 = +2.91%

The same wage rise has no effect on ULC if productivity matches it, and a clear effect if it does not.

MRP theory in six lines

1. MRP = MPP × marginal revenue. MPP falls because of diminishing returns, so the MRP curve slopes down.
2. The MRP curve is the firm’s demand for labour.
3. A wage-taking firm faces a horizontal wage line.
4. It hires up to where MRP = wage.
5. A fall in the wage gives a movement down the curve. A rise in product price or productivity shifts MRP to the right.
6. Workers with higher MRP tend to earn more.

Small reminder: MPP of 12 units and a price of £4 gives MRP = 12 × 4 = £48. With MRP of £48, £36, £24 and £12 for workers one to four and a wage of £30, the firm hires 2.

Worked reminder with a second table. A firm sells at £7 a unit and the MPP of workers one to four is 8, 6, 4 and 2 units.

Workers	MPP	MRP = MPP × £7
1	8	£56
2	6	£42
3	4	£28
4	2	£14

At a wage of £33 the firm hires 2 workers (the second adds £42, the third only £28). If the wage falls to £20 it hires 3: a movement along the MRP curve. A rise in productivity that lifts every MPP by 20% would shift the curve right.

Evaluation of MRP theory: it is hard to apply to team work and public services; it assumes profit-seeking firms, identical workers and a wage the firm cannot influence; real wages also reflect bargaining power.

Must-know distinctions

• Nominal versus real wages.
• Movement along versus shift of the demand curve for labour.
• Productivity versus ULC. High productivity can come with a high wage.
• MPP (output) versus MRP (revenue).
• Price versus marginal revenue when the firm has market power.

Quick self-test

1. A worker’s weekly pay is £540 and the price index is 108 (base year 100). What is the real wage?
2. Wages rise from £8 to £9 and employment falls from 160 to 144. Calculate WED.
3. Does the wage bill in question 2 rise or fall?
4. A firm makes 1,800 units with 20 workers working 30 hours each. Calculate output per hour.
5. A firm pays £15 an hour and produces 5 units an hour. Calculate ULC.
6. Wages index 112 and productivity index 120. Calculate the ULC index.
7. MPP is 12 units and the price is £4. Calculate MRP.
8. Explain why a fall in demand for cars reduces the demand for assembly workers.
9. State one reason why WED may be lower in the short run.
10. Define human capital.

Answers

1. 540 ÷ 108 × 100 = £500.
2. Wage +12.5%, employment -10%: -10 ÷ 12.5 = -0.8 (inelastic).
3. Bill before 8 × 160 = £1,280; after 9 × 144 = £1,296: it rises, as demand is inelastic.
4. 1,800 ÷ (20 × 30) = 3 units an hour.
5. 15 ÷ 5 = £3.00.
6. 112 ÷ 120 × 100 = 93.33.
7. 12 × 4 = £48.
8. Labour demand is derived: fewer cars sold means less output and lower MRP, so firms want fewer workers at each wage.
9. Firms cannot quickly replace labour with machines, so cannot easily respond to a wage rise.
10. The skills, knowledge, qualifications and health embodied in workers.

Where marks are usually lost

• Calling a nominal rise a real rise, or dividing by the index without multiplying by 100.
• Dropping the sign on WED, or saying elastic when the size is below 1.
• Shifting the whole labour demand curve when the wage alone has changed.
• Using the wage rise alone to judge ULC without checking productivity.
• Mixing up productivity per worker with productivity per hour.
• Stating factors without explaining how each changes MRP or WED.
• Drawing MRP and the wage line without naming axes, curves and the equilibrium employment.
• Evaluation that lists points without a judgement on which matters most for the firm or country in the case.

Official syllabus

OCR, A Level in Economics (H460) specification. Component 1, Microeconomics: area of study Labour market, topic Wage determination (the demand-side outcomes and MRP theory).