Derived Demand for Labour

Labour is demanded not for direct satisfaction, but because it helps produce goods and services that consumers, firms or governments demand. It is therefore called derived demand: employers' willingness to hire depends on the expected contribution of labour to output and revenue. Demand for labour is distinct from labour supply, which reflects workers' willingness and ability to work.

How labour demand is derived

A profit-seeking firm compares the additional revenue generated by another worker with the cost of employing that worker. Under standard competitive conditions, it employs labour until the wage rate equals labour's marginal revenue product, subject to an interior optimum.

• Marginal revenue product is the additional revenue obtained by employing one more unit of labour.
• In a competitive product market, the value of marginal product is product price multiplied by marginal product of labour.
• Higher demand for the final product generally raises its price or required output, increasing the firm's demand for labour, other things remaining constant.

What determines labour demand

Labour demand changes with conditions affecting the value or quantity of output that workers can produce.

• Stronger product demand generally shifts labour demand outward, while weaker demand shifts it inward.
• Higher labour productivity can raise the revenue generated by each worker and increase labour demand.
• Technology and capital may substitute for some workers or complement them, so their employment effect depends on the production process.
• A change in wages primarily changes the quantity of labour demanded, while product demand, productivity and technology can shift the labour-demand curve.

Connection with unemployment

Because labour demand is derived from production, unemployment can persist even when workers possess education or skills if firms do not expect sufficient sales or profitable output. A shortfall in aggregate demand can reduce production and create cyclical unemployment.

• Economic growth raises employment only to the extent that additional output requires additional labour.
• Sectoral composition, technology and productivity determine how employment-intensive a given increase in output will be.