Labor Demand in the Long Run
The long-run demand curve for labor shows the relationship between the wage and the quantity of labor demanded over the long run, when the number of firms in the market can change and firms in the market can modify their production facilities - Labor Demand in the Long Run introduction. Although there are no diminishing returns in the long run, the market demand curve is still negatively sloped. As the wage increases, the quantity of labor demanded decreases for two reasons:
•The output effect. An increase in the wage will increase the cost of producing balls, and firms will pass on at least part of the higher labor cost to their consumers: Prices will increase. According to the law of demand, firms will sell fewer balls at the higher price, so they will need less of all inputs, including labor.
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•The input-substitution effect. An increase in the wage will cause the firm to substitute other inputs for labor. At a wage of $4, it may not be sensible to use much machinery in the ball factory, but at a wage of $20, it may be sensible to mechanize the factory, using more machinery and fewer workers. This substitution of other inputs for labor decreases the labor input per unit of output.
There is less flexibility in the short run because firms cannot enter or leave the market and they cannot modify their production facilities. As a result, the demand for labor is less elastic in the short run. That means the short-run demand curve is steeper than the long-run demand curve. The input-substitution effect decreases the labor input per unit of output while the output effect decreases total output. The two effects operate in the same direction, so the market demand curve is negatively sloped. The notion of input substitution applies to other labor markets as well. For the most graphic examples of factor substitution, we can travel from a developed country, such as the United States, Canada, France, Germany, or Japan, to a less-developed country in South America, Africa, or Asia. Wages are much lower in the less-developed countries, so production tends to be more labor intensive. In other words, labor is less costly relative to machinery and equipment, so labor is substituted for these other inputs. Here are some examples:
•Mining. U.S. firms use huge earthmoving equipment to mine for minerals; firms in some less-developed countries use thousands of workers digging by hand. •Furniture. Firms in developed countries manufacture furniture with sophisticated machinery and equipment; firms in some less-developed countries make furniture by hand. •Accounting. Accountants in developed countries use computers and sophisticated software programs; some accountants in less-developed countries use simple calculators and ledger paper.