The market demand for a factor, Macroeconomics

The market demand for a factor 

The market demand curve for any input is not simply the horizontal summation of the individual demand curves of all the firms. This is due to the fact that as the price of the input falls all firms will seek to employ more of this factor and expand their output. Thus, the supply curve of the goods shift to the right leading to a fall in the price of the goods, Px. As the price falls, the individual demand curves will shift to the left. This is shown in figure 10.3(a). Initially, w1 is the wage rate and the firm is at the point a on the demand curve d1 and employs l1 units of labor. Summing over all the employing firms, we obtain the total demand for labor L1 at point A in figure 10.3(b). Now suppose that the wage rate falls to w2, Other things remain the same, the firm would move along d1to b1, increasing the employment of labor to l12. However, other things do not remain the same. When the wage rate falls, all firms tend to demand more labor. As a result output expands. The supply curve of output shifts to the right and the price of the goods falls. As price falls the VMPL curve shifts to the left. Suppose the new VMP curve is d2. Thus, when the wage rate falls to w2 the firm will be in equilibrium at b and not at b1. Summing horizontally for all firms, we get point B of the market demand curve. If the fall in the price of the good was not taken into account we would have obtained the point B1. The point B1, does not, however, belong to the market demand curve for labor.


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Posted Date: 9/13/2012 7:48:50 AM | Location : United States

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