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Firms demand labor and an input to production. The cost of labor to a firm is called the wage rate. This can be thought of as the firm's marginal cost. The additional revenue generated by hiring one more unit of labor is the marginal revenue product of labor (MRPL). This can be thought of as the marginal benefit.
The marginal revenue product of labor (MRPL) is the additional amount of revenue a firm can generate by hiring one additional employee. It is found by multiplying the marginal product of labor (MPL) - the amount of additional output one additional worker can generate - by the price of output. If an employee of a customer support call center can take eight calls an hour (the MPL) and each call earns the company $3, then the MRPL is $24.
We can use the MRPL curve to determine the quantity of labor a company will hire. Suppose workers are available at an hourly rate of $10. The amount a factor adds to a firm's total cost per period is the marginal cost of that factor, so in this case the marginal cost of labor is $10. Firms maximize profit when marginal costs equal marginal revenues, and in the labor market this means that firms will hire more employees until the wage rate (marginal cost of labor) equals the MRPL. At a price of $10, the company will hire workers until the last worker hired gives a marginal revenue product of $10 .
Thus, the downward-sloping portion of the marginal revenue product curve shows the number of employees a company will hire at each price (wage), so we can interpret this part of the curve as the firm's demand for labor. As with other demand curves, the market demand curve for labor is the sum of all firm's individual demand curves.
Shifting the Demand for Labor
There are three main reasons why the demand curve for labor may shift:
Changes to the marginal productivity of labor: Technology, for instance, may increase the marginal productivity of labor, shifting the demand curve to the right. For example, computer technology has increased the productivity (marginal product) of many types of workers. This has led to an increase in the marginal revenue product of labor for these jobs, shifting firms' demand for labor to the right. This both increases the number of employed workers and increases the wage rate.
The prices of other factors of production: The change in the relative price of labor will increase or decrease demand for labor. For example, is capital becomes more expensive relative to labor, the demand for labor will increase as firms seek to substitute labor for capital.
The price of the firm's output: Since the price of the output is a component of MRPL, changes will shift the demand curve for labor. If the price that a firm can charge for its output increases, for example, the MRPL will increase. This is reflected in an outward shift of the demand for labor.