Economics (NCERT) Notes

5.3 Wage Determination in Labour Market

Labour market
•The basic difference between a labour market and a market for goods is with respect to the source of supply and demand.
•In the labour market, households are the suppliers of labour and the demand for labour comes from firms whereas in the market for goods, it is the opposite.
•By labour, we mean the hours of work provided by labourers and not the number of labourers.
•The wage rate is determined at the intersection of the demand and supply curves of labour where the demand for and supply of labour balance.
•To examine the demand for labour by a single firm, we assume that
     •the labour is the only variable factor of production and
     •the labour market is perfectly competitive, which in turn, implies that each firm takes wage rate as given.
     •The firm we are concerned with, is perfectly competitive in nature and carries out production with the goal of profit maximisation.
     •Given the technology of the firm remains the same
     •The law of diminishing marginal product holds.
Marginal product and Marginal Revenue
•The firm being a profit maximiser will always employ labour upto the point where the extra cost she incurs for employing the last unit of labour is equal to the additional benefit she earns from that unit.
     •The extra cost of hiring one more unit of labour is the wage rate (w).
     •The extra output produced by one more unit of labour is its marginal product (MPL)
     •The additional earning of the firm is the marginal revenue (MR) by selling each extra unit of output.
Marginal Revenue Product of Labour (MRPL)
•For each extra unit of labour, a company gets an additional benefit equal to marginal revenue (MR) times marginal product (MPL) which is called Marginal Revenue Product of Labour (MRPL).
     •MRPL = MR × MPL
•Thus, while hiring labour, the firm employs labour up to the point where
     •w = MRPL
•Since we are dealing with a perfectly competitive firm, marginal revenue is equal to the price of the commodity and hence marginal revenue product of labour (MRPL) in this case is equal to the value of marginal product of labour (VMPL).
When will firm hire and fire
•As long as the value of marginal product of labour (VMPL) is greater than the wage rate (w), the firm will earn more profit by hiring one more unit of labour,
•If at any level of labour employment VMPL is less than the wage rate, the firm can increase her profit by reducing a unit of labour employed.
Law of diminishing returns for wage rate
•If a firm employs more of labour, the additional return to extra workers will begin to diminish.
Determination of Wage
•If the wage increases, the demand of labour is reduced
•If the wage increases, the supply of labour is increased 
•The equilibrium wage rate is the rate that equates demand and supply,  
•Wage is thus determined at the point where the labour demand and supply curves intersect.

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