1. Lectures in Microeconomics-Charles W. Upton Long Run Labor Demand

2. The Short Run Demand For Labor The VMP curve is the short run labor demand curve. When the wage rate is w o, L o workers are demanded When the wage rate is w 1, L 1 workers are demanded wowo w1w1 LoLo L1L1 $ L

3. Long Run Labor Demand K L QoQo LoLo KoKo Lets see what happens when the firm can change its other input.

4. Long Run Labor Demand K L QoQo LoLo KoKo Lets see what happens when the firm can change its other input. Here is the initial production isoquant

5. Long Run Labor Demand K L Q1Q1 QoQo L1L1 LoLo K1K1 KoKo Now the firm expands and moves to Q 1

6. Long Run Labor Demand K L Q1Q1 QoQo L1L1 LoLo K1K1 KoKo Now the firm expands and moves to Q 1 Note that here the demand for labor has declined!

7. Long Run Labor Demand K L Q1Q1 QoQo L1L1 LoLo K1K1 KoKo Expansion Line

8. Long Run Labor Demand K L Q1Q1 QoQo L1L1 LoLo K1K1 KoKo Expansion Line We would normally expect an increase in output to lead to a increased demand for both factors.

9. Long Run Labor Demand K L Q1Q1 QoQo L1L1 LoLo K1K1 KoKo Expansion Line We would normally expect an increase in output to lead to a increased demand for both factors. That need not be the case.

10. Long Run Labor Demand The Effect of a Change in Wage Rate L K w L* Let’s see what happens when wages change. Initially the firm is employing L* workers.

11. Long Run Labor Demand The Effect of a Change in Wage Rate L K w w` L*L** Now, the wage rate falls to w`. If the firm kept producing the same amount of output, we would substitute labor for capital.

12. Long Run Labor Demand The Effect of a Change in Wage Rate L K w w` L*L** MC Q* But there is more to the story. What happens to MC ?

13. Long Run Labor Demand The Effect of a Change in Wage Rate L K w w` L*L** MC Q* It probably moves to the right. (Note that this is a fall in MC). Q**

14. Long Run Labor Demand The Effect of a Change in Wage Rate L K w w` L*L** MC Q* It probably moves to the right. (Note that this is a fall in MC). Q** Ergo, the firm increases output

15. Long Run Labor Demand The Effect of a Change in Wage Rate L K w w` L*L** MC Q* It probably moves to the right. (Note that this is a fall in MC). Q** Ergo, the firm increases output So we have two effects on labor demand:

16. Long Run Labor Demand The Effect of a Change in Wage Rate L K w w` L*L** MC Q* It probably moves to the right. (Note that this is a fall in MC). Q** Ergo, the firm increases output So we have two effects on labor demand: Substitution Effect (Lower wages mean more demand for workers)

17. Long Run Labor Demand The Effect of a Change in Wage Rate L K w w` L*L** MC Q* It probably moves to the right. (Note that this is a fall in MC). Q** Ergo, the firm increases output So we have two effects on labor demand: Substitution Effect (Lower wages mean more demand for workers) Scale Effect (Lower wages may mean changed output and that may mean less demand for workers)

18. Long Run Labor Demand The Two Effects Change in Quantity of Labor Demanded = Substitution Effect + Scale Effect

19. Long Run Labor Demand The Two Effects Change in Quantity of Labor Demanded = Substitution Effect + Scale Effect In general, we expect the substitution effect will dominate even if the scale effect is negative.

20. Long Run Labor Demand End ©2006 Charles W. Upton