The demand for labour is central to understanding employment patterns, wage formation, and firm behaviour in competitive and non-competitive markets.
What is labour demand?
Labour demand refers to the number of workers that employers are willing and able to hire at a range of wage rates over a given period. It is not a fixed number but varies with changes in wages and other factors affecting a firm’s willingness or ability to hire. In the same way consumers demand goods and services, firms demand labour as a factor of production—but this demand behaves differently because labour is not an end product, but a means to produce output.
Labour demand is closely linked to the concept of marginal productivity. Firms base hiring decisions on whether the additional output produced by hiring one more worker (marginal product) will bring in enough revenue to cover the cost of employing that worker. The condition for hiring is:
Marginal Revenue Product of Labour (MRPL) = Marginal Product of Labour × Price of Output
Firms will continue to hire workers as long as the MRPL is greater than or equal to the wage rate.
Labour demand as derived demand
The demand for labour is not autonomous. It does not arise independently but is a derived demand—that is, it is derived from the demand for the goods and services that labour helps produce.
If consumers demand more cars, car manufacturers will need to produce more vehicles, which in turn increases the demand for factory workers, engineers, and designers.
If the demand for newspapers falls due to digitalisation, printing companies will cut back on hiring printing staff and delivery drivers.
Because of this dependency, labour demand is affected by broader economic trends. Booms in the economy raise product demand and thus labour demand, while recessions reduce both.
This concept of derived demand is especially important when analysing labour markets for different industries. In cyclical industries like construction or travel, employment is highly sensitive to fluctuations in product demand. In contrast, inelastic product demand—like for essential healthcare—makes labour demand more stable.
Key determinants of labour demand
While wage rate is a key driver of labour demand, several non-wage factors also play a major role in determining how many workers firms will hire. These influence either the position of the labour demand curve or the slope of the curve.
1. Wage rate
The wage rate is the price of labour, and like most prices, it plays a central role in determining how much of a resource is demanded.
There is an inverse relationship between wage rate and quantity of labour demanded.
As wage rates rise, labour becomes more expensive for firms. Holding other factors constant, this reduces the number of workers firms can afford to hire.
As wage rates fall, hiring workers becomes more affordable, encouraging firms to take on more staff.
This relationship is captured in a downward-sloping labour demand curve, illustrating that as wages increase, the quantity of labour demanded falls, and vice versa.
This is also related to the law of diminishing marginal returns. When additional workers are hired, each contributes less and less additional output. This fall in marginal productivity reduces the marginal revenue product, making higher wages unjustifiable unless output prices also rise.
However, the extent of the wage rate’s effect depends on the elasticity of demand for labour, which is covered separately in later topics.
2. Productivity of labour
The productivity of workers—how much output they produce per hour or per worker—affects their marginal revenue product and thus the demand for them.
If labour becomes more productive, the marginal product of labour (MPL) increases.
Since MRPL = MPL × Price of Output, a rise in productivity boosts the MRPL, making workers more valuable to firms.
This results in a rightward shift of the labour demand curve, meaning that firms are willing to hire more workers at each wage rate.
Examples of factors that improve labour productivity:
Better education and training
Use of advanced technology
Improved work organisation and management
Access to better capital equipment
In service sectors, productivity can also rise due to better scheduling, customer handling systems, or data-driven performance monitoring.
Conversely, if productivity falls—due to inefficiency, poor morale, or inadequate capital—firms will be less inclined to hire at existing wage levels, shifting the demand curve leftward.
3. Price of substitutes for labour (capital)
In many production processes, firms can substitute labour with capital. The decision depends largely on the relative cost and productivity of each.
If capital goods such as machinery, automation systems, or software become cheaper or more efficient, firms may replace labour with machines, reducing the demand for workers.
A fall in the cost of substitutes shifts the labour demand curve to the left.
Conversely, if capital becomes more expensive, difficult to operate, or less reliable, labour becomes relatively more attractive, and the demand curve shifts right.
The degree of substitution depends on the nature of the task:
In sectors like manufacturing, clerical work, and logistics, capital-labour substitution is easier.
In roles requiring emotional intelligence, human judgement, or creativity—such as counselling, education, or design—substitution is much harder.
Firms will evaluate the marginal cost per unit of output when deciding whether to use labour or capital.
4. Total revenue from output
Total revenue is a product of output quantity and price. Firms experiencing strong sales growth or increased product prices will have higher total revenues, which allows them to invest more in production—including hiring more workers.
Greater revenue means the firm can afford higher employment without sacrificing profit margins.
It also implies that the marginal revenue from extra output is higher, thus increasing the MRPL of workers.
As a result:
A rise in total revenue leads to a rightward shift in the labour demand curve.
A decline in revenue—due to lower product prices, falling demand, or increased competition—reduces the financial incentive to employ, shifting the demand curve leftward.
This also connects with the derived demand concept. Higher output demand = higher product revenue = greater labour demand.
Firms in highly competitive markets may be more sensitive to changes in total revenue than monopolistic firms that can set prices above marginal cost.
Diagrams to illustrate labour demand
Visual representation is essential to understanding how labour demand functions. Below are explanations of diagrams that can be used to support this topic.
Downward-sloping labour demand curve
This diagram demonstrates the inverse relationship between wage rate and quantity of labour demanded.
Y-axis: Wage rate
X-axis: Quantity of labour
The curve slopes downwards from left to right.
Key explanation: As wages fall, firms find it cheaper to hire workers, so the quantity demanded rises.
This curve assumes ceteris paribus—all other factors held constant—so the shape reflects only the effect of wage changes.
Shifts in the labour demand curve
Changes in non-wage determinants such as productivity, capital costs, or total revenue will shift the entire labour demand curve.
A rightward shift indicates increased demand for labour at each wage rate.
A leftward shift reflects a reduction in labour demand across all wage rates.
Example scenarios:
Rightward shift:
A tech firm introduces software that enhances employee output.
Consumer demand for the firm’s product surges due to a viral trend.
Leftward shift:
A new automation tool replaces human workers in a warehouse.
A fall in the price of the firm’s product reduces revenue and profits.
In diagrams:
Start with the original demand curve (labelled D1).
Shift to a new position (e.g. D2 for an increase, or D3 for a decrease).
Use arrows to indicate the direction of the shift.
Movement along the demand curve vs. shifts of the curve
It’s important to distinguish between:
Movement along the curve: Caused by changes in the wage rate alone.
Shift of the curve: Caused by non-wage factors (e.g. productivity, capital costs, revenue).
Students often confuse these. In exam answers, be explicit: if wages change, describe the movement along the curve; if other factors change, explain how the curve itself shifts.
Real-world applications of labour demand
Understanding labour demand is not just theoretical—it explains many real-world employment trends.
Technology sector: High demand for programmers and data analysts due to strong product demand and high productivity, leading to rising wages.
Retail industry: Decline in high-street retail has reduced labour demand due to falling total revenues and capital substitution (self-checkout machines).
Hospitality: After the COVID-19 pandemic, demand rebounded quickly, increasing the demand for staff—especially in areas with high consumer footfall.
In the public sector, labour demand may be less responsive to revenue because services are not sold for profit, but rather funded by government budgets.
Labour demand is also affected by global competition and outsourcing. If firms find cheaper labour abroad, domestic demand may fall unless offset by productivity or quality advantages.
Firms’ hiring decisions reflect a complex balancing act between wage costs, productivity, available capital, and expected future demand. Understanding the factors influencing labour demand is key to analysing the broader economy, labour market trends, and policy decisions.
FAQ
The marginal revenue product of labour (MRPL) is a crucial concept in determining how many workers a firm chooses to employ because it measures the additional revenue generated from employing one more worker. A profit-maximising firm will hire workers up to the point where the MRPL equals the wage rate. If MRPL exceeds the wage, the worker adds more to revenue than they cost, making them a profitable hire. If MRPL is less than the wage, the worker adds less to revenue than they cost, making them unprofitable. MRPL is calculated by multiplying the marginal product of labour (additional output from an extra worker) by the price at which the output is sold. Therefore, any change in productivity or output price directly affects MRPL and hiring decisions. Understanding MRPL helps explain not only how many workers are hired, but also wage differentials between jobs and industries with different output prices and productivity levels.
The time period significantly affects how responsive the demand for labour is to wage changes. In the short run, labour demand tends to be more inelastic because firms have limited flexibility to adjust their production processes or substitute labour with capital quickly. Contracts, training requirements, and fixed capital all restrict short-term responsiveness. For example, a firm cannot immediately replace workers with machines or restructure its production process after a wage increase. However, in the long run, firms have more time to adapt. They may invest in automation, relocate production, or redesign workflows to reduce reliance on expensive labour. As a result, labour demand becomes more elastic in the long run. This means that over time, a wage rise could lead to a more significant fall in employment, especially in industries where capital can effectively replace labour. Understanding this dynamic is important when evaluating the potential impact of wage changes and labour market policies.
Yes, while technological advancements often replace labour in routine or manual tasks, they can also lead to an increase in labour demand, particularly for skilled workers. This is known as labour-augmenting technological change, where technology increases the productivity of workers rather than substituting them. For example, software tools can enable professionals like designers, marketers, or analysts to do more complex work more efficiently, increasing their marginal productivity and making them more valuable to firms. As a result, the marginal revenue product of labour rises, shifting the demand curve to the right. Furthermore, technology often creates new sectors and job roles—such as app development, cybersecurity, and digital marketing—which previously did not exist. The overall effect of technology on labour demand depends on whether the productivity gains it brings are complementary to labour (increasing demand) or substitutive (reducing demand). In many knowledge-based and service-oriented industries, technological progress has increased—not decreased—labour demand.
Firms do not make hiring decisions based solely on current conditions—they also consider their expectations about future demand. If a firm anticipates a sustained increase in product demand, perhaps due to seasonal trends, favourable market forecasts, or new contracts, it may increase its current hiring to prepare for the expected growth. This proactive hiring boosts current labour demand. Similarly, if firms expect a downturn, they may hold off on recruitment or even begin downsizing before demand actually falls, reducing labour demand in advance. Expectations influence labour demand by shaping investment and output planning, especially in industries where production lead times are long. For example, a construction firm bidding for future contracts may increase hiring if it expects to secure large projects. Expectations can also be shaped by policy signals, such as interest rate changes or trade agreements, which influence how firms assess future profitability. Thus, anticipated changes in market conditions play a crucial role in current labour demand decisions.
Even if the wage rate is the same across industries, labour demand can vary significantly due to differences in productivity, revenue potential, capital intensity, and substitutability of labour. For instance, in industries like technology or finance, workers typically have higher marginal productivity and contribute to the sale of high-value products or services. As a result, their marginal revenue product of labour is much higher, leading to greater demand for labour at a given wage. In contrast, low-margin sectors like retail or hospitality often have lower MRPL, making firms more sensitive to wage changes and limiting how many workers they can afford to hire. Additionally, some industries rely heavily on capital (e.g. automotive manufacturing), while others depend more on labour (e.g. teaching or healthcare), affecting the base level of labour demand. Labour market regulations, entry barriers, and required skill levels also differ across sectors, which further explains why equal wage rates do not translate into equal labour demand across industries.
Practice Questions
Explain why the demand for labour is considered a derived demand.
The demand for labour is a derived demand because it depends on the demand for the goods and services that labour helps to produce. Firms do not hire workers for their own sake but because those workers contribute to output that can be sold in markets. When consumer demand for a product increases, firms expand production and require more workers, increasing labour demand. Conversely, if product demand falls, fewer workers are needed. Therefore, changes in final output demand directly affect the demand for labour, making it a derived rather than a primary demand.
Analyse how an increase in labour productivity might affect the demand for labour.
An increase in labour productivity means that each worker produces more output per time period, raising the marginal product of labour. Assuming the price of the final good remains constant, the marginal revenue product of labour (MRPL) will increase, making each worker more valuable to the firm. This leads to a rightward shift in the demand for labour curve, as firms are willing to hire more workers at any given wage. Improved productivity can also increase competitiveness and output, generating more revenue, which further supports increased labour demand in the long run.
