Cambridge International as and a level Economics Ebook

Derived demand: 
where the demand for a good or service 
depends upon the use that can be made from it.
KEY TERM
Th
e analysis that follows is based upon two important 
assumptions:
1
The firm wishing to hire labour is operating in a 
competitive market. There are many buyers and sellers of 
labour, and no single firm or worker can aff ect the wage 
that is paid.
2
The firm is a profit maximiser. Its demand for labour and 
supply of labour are based on it maximising the diff erence 
between total revenue and total costs.
TOP TIP
The demand for labour is unusual since it is derived from 
the benefits that accrue to those who hire labour. This 
makes the demand for labour diff erent from most other 
things that are demanded.
The marginal revenue product of labour
Th
e profi t-maximising fi rm is concerned with how much 
the output it produces is worth to the business. We 
must therefore take into account the cost of employing 
labour – the wage rate. Let us assume that this is $600 per 
month and, using earlier data from 
Table 7.3
, let us assume 
that a unit of clothing sells for $10.
When the fi rm hires the fi rst worker, this worker 
generates $1,000 of revenue for the fi rm; this in turn 
represents $400 of profi t. Th
e amount of revenue generated 
by an additional worker is referred to as the 
marginal 
revenue product
of labour. Adding a further worker 
generates another $800 and $200 profi t. Th
ere comes a 
point when, aft er the third worker has been employed, a 
further worker adds more to costs than to revenue (it still 
costs $600 to employ the worker but only $400 worth of 
clothing is produced). So, above this level of employment, 
the value of the marginal
 
product that is being produced 
is less than the wage. Th
is clearly makes no sense to the 
fi rm. It can therefore be deduced that the fi rm should hire 
workers up to the point where the value of the marginal 
product of labour equals the wage that is being paid. Th
e 
demand curve for labour can therefore be represented by 
the value of the marginal product curve. Th
is is shown in 
Figure 8.10
. So, in general terms:
■
a firm should continue to hire labour as long as the 
additional worker adds more to revenue than he or she adds 
to the firm’s costs
■
the market wage is determined by the marginal revenue 
product of labour
■
the marginal revenue product curve is therefore the firm’s 
demand curve for labour
■
if the wage rate rises or falls, then fewer or more workers 
will be employed.
It follows from this analysis that the wages paid to 
workers are a direct refl ection of their marginal revenue 
product. So, a street cleaner has a lower marginal 
1000
800
600
400
200
Number of workers employed
0
1
2
3
4
5
6
V
alue of mar
ginal pr
oduct
Market wage
Value of marginal
product
Profit-
maximising
output