The Demand for Labor

This chapter identifies assumptions underlying the proposition that labor demand is a downward-sloping function of the wage rate. The fundamental assumption of labor demand theory is that firms—the employers of labor—seek to maximize profits. Changing the levels of labor or capital employed, of course, will add to or subtract from the firm&s;s total costs. The marginal expense of labor (MEL) that is incurred by hiring more labor is affected by the nature of competition in the labor market. From the profit-maximizing decision rules discussed earlier, it is clear that the firm should keep increasing its employment of labor as long as labor&s;s marginal revenue product exceeds its marginal expense. The less responsive labor supply is to cause changes in wages, the fewer the employees who withdraw from the market and the higher the proportion of the tax that gets shifted to workers in the form of a wage decrease.