OxfordAQA International AS and A-level Economics: Demand for and supply of labour (9640)

This guide is written for the OxfordAQA International AS and A-level Economics (9640) specification, version 1.2. It covers sections 3.3.4.1 (the demand for labour and marginal productivity theory) and 3.3.4.2 (the supply of labour to different labour markets). Section 3.3 is extra International A2 content. Section 3.5 quantitative skills may appear in any unit, and the sums here use QS2 (percentages), QS6 (revenue and totals), QS8 (elasticity) and QS9 (interpreting data). Every firm, place and figure is invented and illustrative.

How wages and employment are determined when demand meets supply is covered on other pages, so this guide stops at the two curves. The revision notes condense this page, and the practice questions let you check your skills. Course pages: OxfordAQA A-level Economics hub and checklist. Not sure where to start? Take a free 10-minute diagnostic. Earlier ideas you will use: productivity and returns, costs and revenue and elasticity of demand.

What you must be able to do

Section	Specification content	What it means in practice
3.3.4.1	Derived demand, marginal productivity theory, the labour demand curve, causes of shifts, determinants of elasticity	Explain, calculate marginal revenue product, draw and shift the curve, calculate and discuss elasticity
3.3.4.2	Monetary and non-monetary influences on supply to an occupation, the supply curve, causes of shifts	Explain why people choose an occupation and what moves the occupation’s supply curve

The specification leaves out how one person decides how much to work, and it leaves out the backward-bending supply curve. Everything below is about a whole occupation or market.

1. Derived demand (3.3.4.1)

An employer hires someone to get output sold to customers, not for the sake of employing anyone. So the demand for labour is a derived demand: it is passed back from customers’ spending on the product to the workers who make it. If demand for a firm’s goods rises, it needs more output and so more workers. If demand collapses, so does its demand for labour. The same is true of any factor of production.

2. Marginal productivity theory

Marginal physical product (MPP) is the addition to total output when one more worker joins the team, with land and equipment unchanged. Because of diminishing marginal returns, MPP eventually falls as more workers share the same land or equipment.

Marginal revenue product (MRP) is the addition to the firm’s sales revenue from taking on one more worker.

MRP = MPP × marginal revenue (MR)

If the firm is a price taker in its product market, MR equals the price. A profit-maximising firm compares each worker’s MRP with the extra cost of that worker. For a firm taking the wage as given, the extra cost is the wage. It keeps hiring while MRP is at least the wage, and stops when MRP drops below it. Because MRP falls as workers are added, the firm’s MRP curve is its demand curve for labour. Adding together the curves of all the firms gives the market demand curve.

Worked example (a tomato farm, invented). Tomatoes sell at 2.00 per kg in a competitive market. The table shows daily output with a fixed greenhouse.

Workers	Total output (kg)	MPP (kg)	MRP (price 2.00)
1	40	40	80
2	76	36	72
3	106	30	60
4	130	24	48
5	148	18	36
6	160	12	24

Workings: MPP of worker 3 = 106 − 76 = 30 kg, and MRP = 30 × 2.00 = 60.

At a daily wage of 50, workers 1 to 3 each have MRP above 50, but worker 4 has MRP of only 48, so the farm hires 3. Check it with totals: revenue 106 × 2.00 = 212 less wages 150 leaves 62. With 4 workers, revenue is 260 and wages are 200, leaving 60, which is lower. At a wage of 70 it hires 2, at 40 it hires 4, and at 30 it hires 5. Those wage and employment pairs are points on the farm’s demand curve for labour.

Daily wage	70	50	40	30
Workers demanded	2	3	4	5

Show the wage rate on the upright axis and the quantity of labour on the flat axis. The MRP curve slopes down from left to right. A fall in the wage is a movement down the curve to a larger number of workers.

If the product market is imperfect, the firm must cut its price to sell more, so MR is below price. A worker with MPP of 12 units, selling at a price of 6.00 where MR is only 4.50, has MRP = 12 × 4.50 = 54, not 72. The demand curve for labour is then steeper still, because MRP falls for two reasons: diminishing returns and falling MR.

Evaluation of the theory. Marginal productivity theory is a useful model, but its assumptions are strong.

• Output is hard to attribute to one worker in a team, or in a job such as nursing or teaching with no market price for output.
• Workers are assumed to be identical, and firms are assumed to know each worker’s MRP.
• Firms may not aim to maximise profit. Hiring also involves training and firing costs, so the response to a pay change may be slow.
• It works best in the short run, with other factors fixed. In the long run firms can change capital.

3. Shifts in the demand for labour

A different wage rate takes you to another point on the same curve. Anything else that changes MRP at each wage shifts it.

Cause	Effect on MRP	Direction
Rise in demand for the product, or a higher product price	MR rises	Right
Rise in productivity (training, better equipment, new technology that complements workers)	MPP rises	Right
Fall in the price of a complementary factor	Hiring becomes more profitable	Usually right
Fall in the price of a substitute such as machinery	Labour replaced by it	Usually left
Higher non-wage costs imposed on employers	Extra cost per worker	Left

Worked example. The price of tomatoes rises from 2.00 to 2.50. MRP is now 100, 90, 75, 60, 45 and 30 (MPP × 2.50). At a wage of 50 the farm hires 4 workers, because the fourth now has MRP of 60, while a fifth would add only 45. Employment at that wage rises from 3 to 4: the curve has shifted right. This is derived demand at work.

A rise in productivity gives the same result. If better tools add 6 kg to each worker’s MPP, the MRP column becomes 92, 84, 72, 60, 48 and 36, and at a wage of 50 the farm again hires 4. Labour-saving technology can shift the curve left if it replaces workers, so state whether the technology complements or replaces labour.

4. Elasticity of demand for labour

Price elasticity of demand for labour (PEDL) = % change in the number employed ÷ % change in the wage rate. It is normally negative. Ignore the sign when you describe size, but say which you have done.

Worked example (a depot, invented). The wage rises from 12.00 to 13.80, and employment falls from 400 to 376.

• % change in wage = 1.80 ÷ 12.00 × 100 = 15%.
• % change in employment = −24 ÷ 400 × 100 = −6%.
• PEDL = −6 ÷ 15 = −0.4, which is inelastic.
• The wage bill rises from 4,800 to 376 × 13.80 = 5,188.80, an increase of 8.1%.

If employment had instead fallen to 320, that is −20%, so PEDL = −20 ÷ 15 = −1.33, which is elastic, and the wage bill falls to 4,416, a fall of 8%. When demand is inelastic, workers who keep their jobs gain more than is lost by those who go. When it is elastic, the reverse is true.

Determinants of PEDL

• Proportion of labour costs in total costs. If labour is 60% of costs, a 10% pay rise adds 6% to the firm’s whole cost bill. If it is 5% of costs, the addition is only 0.5%. The bigger the cost shock, the larger the cut in hiring. Labour demand is less elastic where labour is a small share of costs.
• Ease of substitution. If machines or other workers can do the job at similar cost, firms switch away from dearer labour: more elastic. Skilled, specialised tasks are less elastic.
• Price elasticity of demand for the product. A wage rise lifts costs and prices. If customers are price sensitive, sales and output fall sharply, so employment falls sharply.
• Time. In the short run firms are tied to equipment and contracts. Over a longer period they can redesign production, so demand for labour becomes more elastic.

The chain of reasoning for a wage rise: higher wage, higher unit costs, higher price or lower profit, lower quantity sold (a bigger fall if the product is elastic), lower output, fewer workers (the output effect). Firms may also switch to capital (the substitution effect).

5. The supply of labour (3.3.4.2)

The market supply curve of labour to an occupation links each wage with the number of people prepared to work in that occupation. It slopes upward: a higher wage attracts workers from other occupations and from outside the labour force.

People weigh up the whole package, not only pay. Monetary factors include the wage, overtime, bonuses, commission, pension contributions and other benefits. Non-monetary factors include hours and flexibility, working conditions and risk, job security, status and satisfaction, holidays, training and promotion prospects, and travel to work. Wage differences between occupations partly reflect these differences. A pleasant job may attract workers at a lower wage than an unpleasant one.

Different labour markets have different elasticities of supply. Define wage elasticity of supply of labour = % change in workers willing to supply ÷ % change in the wage.

Worked example. Wages rise by 10% in two invented markets. In general warehouse work, the number of willing workers rises from 1,000 to 1,150, which is 15%, so elasticity = 15 ÷ 10 = 1.5 (elastic). In a specialist technician occupation, the number rises from 200 to 206, which is 3%, so elasticity = 0.3 (inelastic).

Why? Specialist jobs need long training, qualifications and skills tied to one occupation, so workers cannot move in quickly. Easier entry, high occupational and geographical mobility, spare capacity (unemployed workers) and a longer time period all make supply more elastic.

Shifts in supply. A change in the wage is a movement along the curve. A shift needs another cause:

• A change in wages or conditions in rival occupations. If pay rises elsewhere, workers leave and supply shifts left.
• Better or worse non-monetary conditions, such as shorter hours.
• A change in the number of qualified people, from training, education, immigration or demographics.
• Barriers to entry, such as new licensing or qualification rules, which shift supply left.

Supply schedule, invented occupation	Wage 14	Wage 16	Wage 18
Before: workers willing	180	240	300
After shorter hours: workers willing	240	300	360

Each wage now attracts 60 more workers, a shift right.

Common errors

• Calling a wage change a shift of the curve. It is a movement along.
• Using price instead of MR when the firm faces a falling demand curve for its product.
• Hiring while MPP is positive rather than while MRP is at least the wage.
• Writing “labour is demanded because people want jobs”. Employers’ demand is derived from the demand for output.
• Treating elasticity of demand for labour as fixed. It depends on the determinants and the time period.
• Discussing only pay in supply answers. The spec includes non-monetary considerations.

Official syllabus

OxfordAQA International AS and A-level Economics (9640), specification version 1.2, first teaching September 2020, published by OxfordAQA. See sections 3.3.4.1 and 3.3.4.2, and the quantitative skills in section 3.5.