Lesson: The Theory of Labor Markets

Demand for Labor in Imperfectly Competitive Output Markets

Demand for Labor in Imperfectly Competitive Output Markets

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  • In monopolies and oligopolies, companies sell their products and services in a perfectly competitive industry. However, they may face a downward sloping demand curve for output. This means that to sell more, the companies must lower their price.
  • When the company lowers its price, it also has to consider its costs related to labor. 
  • Companies hire workers at a pay where the market wage equals the marginal revenue product.
  • Market wage requires research. From a company's perspective, market wage involves the following:
    • identifying how much the employee is worth in comparison to other employees
    • how much the employee is worth to the company
    • what the employee would earn in another company in the same industry
    • the amount of money the employee is willing to accept

If the employer does not sell its output in a perfectly competitive industry, they face a downward sloping demand curve for output, which means that to sell additional output the firm must lower its price. This is true if the firm is a monopoly, but it is also true if the firm is an oligopoly or monopolistically competitive. In this situation, the value of a worker’s marginal product is the marginal revenue, not the price. Thus, the demand for labor is the marginal product times the marginal revenue. So (MR = marginal revenue):

begin mathsize 22px style D e m a n d space f o r space L a b o r space equals space M P subscript L space cross times space M R end style

For firms with some market power in their output market, the value of additional output sold is the firm’s marginal revenue. Since MPL declines with additional labor employed and since MR declines with additional output sold, the firm’s marginal revenue declines as employment increases.

Everything else remains the same as we described above in the discussion of the labor demand in perfectly competitive labor markets. Given the market wage, profit-maximizing firms will hire workers up to the point where the market wage equals the marginal revenue product, as the figure here shows.