Demand for labour and Wage determination

Labour demand is a derived demand, in other words the employer's cost of production is the wage, in which the business or firm benefits from an increased output or revenue. The determinants of employing the addition to labour depends on the Marginal Revenue Product (MRP) of the worker. The MRP is calculated by multiplying the price of the end product or service by the Marginal Physical Product of the worker. If the MRP is greater than a firm's Marginal Cost, then the firm will employ the worker. The firm only employs however up to the point where MRP=MC, not lower, in economic theory.

In simple words, At a given time and with a given state of technology there exists a relationship between the quantity of labour inputs and the amount of outputs. By the law of diminishing returns, each additional unit of labour input will add a smaller and smaller slab of output. In this diagram shown below we can see that at 5 units of labour, the general wage level is $10 per unit.

Wage differences exist, particularly in mixed and fully/partly flexible labour markets. For example, the wages of a doctor and a port cleaner, both employed by the NHS, differ greatly. But why? There are many factors concerning this issue. This includes the MRP (see above) of the worker. A doctor's MRP is far greater than that of the port cleaner. In addition, the barriers to becoming a doctor are far greater than that of becoming a port cleaner. For example to become a doctor takes a lot of education and training which is costly, and only those who are socially and intellectually advantaged can succeed in such a demanding profession. The port cleaner however requires minimal training. The supply of doctors therefore would be much more inelastic than the supply of port cleaners. The demand would also be inelastic as there is a high demand for doctors, so the NHS will pay higher wage rates to attract the profession.