Ecomonics

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Nancy Proffit
Economics Individual Paper
July 17, 2012
Labor demand is derived from the firms desire to maximize profits. This is a basic assumption of labor demand. Will the firms continually try to make changes that will improve the profitability of the firm? We assume that yes they will. Firms are basically price takers. Now their main decision is what quantity of their product to produce. This is because as they hire more people they basically increase output so the decision to hire more people and the decision to produce more are basically the same decision. The optimal output will equate marginal revenue with marginal cost. Marginal revenue is the product price in a purely competitive market. Marginal cost is therefore the cost to produce that unit. MPl is the change in output of the firm. What happens when a firm decides to produce more? They must hire more labor assuming that capital remains constant. If a firm could continuously hire more people and increase their MRP then we would live in a utopian society with no unemployment and peace and happiness everywhere. But alas we live in a world with diminishing returns and as the firm obtains more people it reaches a point where each new person costs a little more when compared with their output then the person hired before them. A good example of this is digging a hole 4 feet by 8feet by 6 feet. One person would do it in about half the time that two people could do it. But three people would not do it in one third of the time. In fact soon you couldn’t fit all of the people into the hole and it would be so cramped that it would actually take longer to finish the hole. If this happened then they would have a negative marginal product of labor. So the firm should keep hiring people until its marginal revenue product exceeds its marginal expense. But can they get people to come to their camp? Sometime scarcity in the labor force pushes the wage rate up and this increases the marginal expense this will shift...
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