You are viewing a free preview of this lesson.
Subscribe to unlock all 10 lessons in this course and every other course on LearningBro.
The demand for labour is fundamentally different from the demand for consumer goods. Firms do not hire workers for their own sake — they hire workers because of the output those workers can produce and sell. This insight underpins one of the most important concepts in labour economics: derived demand.
Key Definition: The demand for labour is a derived demand — it is derived from (depends upon) the demand for the final good or service that labour is used to produce.
If consumers increase their demand for electric vehicles, firms such as Jaguar Land Rover will need to hire more engineers, assembly-line workers, and battery technicians. Conversely, a fall in demand for printed newspapers reduces the demand for journalists and print workers.
This principle was formalised by Alfred Marshall (1890) in his Principles of Economics. Marshall identified four conditions that determine the elasticity of derived demand (Marshall's Rules of Derived Demand):
| Marshall's Rule | Explanation | Example |
|---|---|---|
| Substitutability of other factors | The easier it is to substitute capital for labour, the more elastic the demand for labour | Self-checkout machines replacing retail cashiers |
| Elasticity of demand for the final product | The more price-elastic the demand for the product, the more elastic the demand for labour | Fast-fashion garment workers vs. bespoke tailors |
| Proportion of labour cost to total cost | The greater labour's share of total costs, the more elastic the demand for labour | Labour-intensive care homes vs. automated factories |
| Elasticity of supply of other factors | The more elastic the supply of substitute factors, the more elastic labour demand | Readily available robotic welding arms vs. scarce specialist equipment |
Exam Tip: Marshall's Rules are frequently tested in 25-mark essay questions. You do not need to memorise all four in isolation — instead, practise applying each rule to a real-world industry. Examiners reward application over recall.
The neoclassical theory of labour demand was developed by John Bates Clark (1899) and refined by John Hicks (1932) in The Theory of Wages. The central proposition is that a profit-maximising firm will hire workers up to the point where the marginal revenue product of labour (MRP_L) equals the marginal cost of labour (MCL).
MRP_L = MPP_L × MR
In a perfectly competitive product market, MR = Price, so:
MRP_L = MPP_L × P
| Workers | Total Output | MPP_L | Price (£) | MRP_L (£) |
|---|---|---|---|---|
| 1 | 10 | 10 | 5 | 50 |
| 2 | 22 | 12 | 5 | 60 |
| 3 | 32 | 10 | 5 | 50 |
| 4 | 40 | 8 | 5 | 40 |
| 5 | 46 | 6 | 5 | 30 |
| 6 | 50 | 4 | 5 | 20 |
Notice that MPP_L initially rises (due to specialisation and division of labour) but then falls — this reflects the law of diminishing marginal returns, which states that as additional units of a variable factor (labour) are added to fixed factors (capital, land), the marginal product eventually declines.
If the wage rate is £40 per worker, the firm hires 4 workers (where MRP_L = W = £40). Hiring a 5th worker would add only £30 of revenue but cost £40 — reducing profit.
The downward-sloping portion of the MRP_L curve is the firm's demand curve for labour in a competitive labour market. As the wage falls, the firm moves down the MRP_L curve and hires more workers; as the wage rises, the firm moves up and hires fewer.
Shifts in the demand for labour (shifts in the MRP_L curve) occur when:
While MRP theory provides the theoretical framework, real-world labour demand is also influenced by:
Exam Tip: When evaluating MRP theory, always note its assumptions: perfect competition in product and labour markets, homogeneous labour, and perfect information. In reality, these rarely hold. Firms often cannot precisely calculate MRP_L, and wages are frequently set by negotiation, custom, or government regulation rather than by marginal productivity alone.
The responsiveness of the quantity of labour demanded to a change in the wage rate is measured by the wage elasticity of demand for labour. This concept is explored in greater depth in Lesson 3, but it is worth noting here that the elasticity depends on the factors identified in Marshall's Rules (see the table at the top of this lesson).
A firm that can easily replace workers with machines (high substitutability) will have a more elastic demand for labour — a wage increase leads to a proportionally larger fall in employment. In contrast, a firm that relies on irreplaceable human skills (e.g., a theatre company) will have inelastic demand — employment changes little even when wages rise.
The demand for labour is also cyclical — it rises during economic booms and falls during recessions:
| Phase | Effect on Labour Demand | UK Example |
|---|---|---|
| Expansion | Rising consumer spending increases product demand, raising derived demand for labour | 2013–2019: UK employment rose by 2.7 million |
| Recession | Falling demand for goods/services reduces derived demand; firms shed labour | 2008–2009 financial crisis: UK unemployment rose from 5.2% to 7.9% |
| Recovery | Firms initially increase hours/overtime before hiring new workers | Post-COVID 2021: vacancies hit record 1.3 million |
Labour hoarding is the practice of retaining workers during a downturn even when MRP_L temporarily falls below the wage. Firms do this to avoid the costs of firing and rehiring (recruitment, training, loss of firm-specific human capital). The UK's furlough scheme (Coronavirus Job Retention Scheme, 2020–2021) effectively subsidised labour hoarding, peaking at 8.9 million employees furloughed in May 2020.
Exam Tip: When discussing the demand for labour, always consider the time dimension. In the short run, demand for labour may be relatively inelastic because firms cannot easily adjust their capital stock. In the long run, firms can invest in automation, relocate production overseas, or restructure their operations, making demand more elastic.
| Concept | Key Point |
|---|---|
| Derived demand | Labour demanded because of demand for the final product |
| MRP_L | Additional revenue from one more worker = MPP_L × MR |
| Hiring rule | Hire where MRP_L = MCL (or MRP_L = W in competitive markets) |
| MRP curve | Downward-sloping portion = demand curve for labour |
| Shifts in demand | Caused by changes in product demand, productivity, technology, factor prices |
| Elasticity of demand | Depends on substitutability, product demand elasticity, labour cost share, time period |
| Business cycle | Demand for labour is cyclical; labour hoarding smooths fluctuations |
Exam Tip: In a 15-mark question on "factors affecting the demand for labour," structure your answer around derived demand, MRP theory, and then real-world factors (technology, regulation, globalisation). Always include at least one diagram and one evaluative point to access the top mark band.
For this topic, you should be able to draw and annotate the following diagrams from memory:
The MRP curve — showing diminishing marginal returns, with MRP_L on the vertical axis and quantity of labour on the horizontal axis. Mark the profit-maximising employment level where MRP_L = W.
A shift in the demand for labour — showing how an increase in product demand shifts the MRP_L curve rightward, increasing both the equilibrium wage and employment.
The derived demand relationship — a two-panel diagram showing the product market on the left (increase in demand for the good) and the labour market on the right (resulting shift in demand for labour). This demonstrates the link between product and factor markets clearly.
Exam Tip: Diagrams are not optional at A-Level. A well-drawn, fully labelled diagram can earn up to 4 marks on its own in a 15-mark question. Always label axes, curves, equilibrium points, and any shifts. Use arrows to show the direction of change and annotate the new equilibrium.