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This document discusses how companies can achieve profit maximization through optimal employment levels in a competitive labor market. It explains that in a competitive labor market, the equilibrium wage is determined by the intersection of the downward-sloping labor demand curve and the upward-sloping labor supply curve. A profit-maximizing firm will hire workers up until the point where the marginal revenue product of labor equals the market wage rate, as hiring additional workers beyond this point would result in higher costs than revenues.

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30 views

Question B

This document discusses how companies can achieve profit maximization through optimal employment levels in a competitive labor market. It explains that in a competitive labor market, the equilibrium wage is determined by the intersection of the downward-sloping labor demand curve and the upward-sloping labor supply curve. A profit-maximizing firm will hire workers up until the point where the marginal revenue product of labor equals the market wage rate, as hiring additional workers beyond this point would result in higher costs than revenues.

Uploaded by

Je Hoe
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Economics for Managers

Academic: Dr. Rubi Ahmad

How to achieve profit maximization and the optimal level of employment in a competitive labor market

Student: Jens Hoenig (NGC100205)

Introduction
For companies, the economic goal in general is to maximize their profits. The key decisions are the determination of the output level to produce and therefore which and how much inputs to use to manufacture this output. In economic theory there are the three production factors capital, land and labor which get combined by a company to produce the optimum output level that returns the greatest profit. The following text is concerned with the production factor labor and the optimal level of employment to maximize the profits for the company in a competitive labor market.

Competitive labor market


Perfect competition in a factor market is characterized by an intersection of the factor market supply and demand curves, whereby the curves are determined by the price per unit (P) and the corresponding total market quantity of an input (Q). We assume that the input supply curve is upward sloping, which means an increase in the input price P, results in an increase in quantity supplied of input Q. In contrast, the input demand curve would be downward sloping whereupon a decrease in P yields an increase in quantity demanded for Q. Now lets apply this market model to the labor market. A perfectly competitive labor market is a composite of many firms which

demand labor and many individual workers which supplies their individual labor. The price per unit on the labor market is reflected by the wage. The demand curve includes all firms hiring and indicates the total number of workers (Q), which all firms in a labor market want to employ at each wage rate (PL). A decrease in the wage rate will cause an increase in firms labor demand therefore the demand curve will slope downward. For every wage level, there are numbers of potential workers, each of whom has a wage below which he will not work (his reservation wage). The labor market supply curve can be derived by the summation of individual workers supply. As the market wage increases, more and more people become willing to work, hence the greater the quantity of labor supplied which is represented by the upward sloping labor supply curve. As a consequence of the perfect competition, both, the companies as well as the

individual workers are wage takers, which means that neither a company nor a single worker can affect the market wage (PL). The market determines a competitive wage (equilibrium price), where the demand equals the supply of labor.

Profit maximization
According to the marginal approach firms should take any action that adds more to its revenues than it adds to its costs. When we view a company as a buyer in a resource of the factor market, we assume the same principle of marginal decision making. The amount of output that one additional worker can contribute to the total output of the firm is called the Marginal Product of Labor

(MPL). Due to the law of marginal diminishing returns it

declines as the size of the workforce grows. The Revenue Marginal Product

(MRP) displays the change in the firms revenues when it employs one more unit of the resource. MRP for any change in employment will equal the price of output (PQ) times the marginal product of labor (MPL): MRP = PQ x MPL. To track changes on the cost side, we use the term Marginal Factor Cost (MFC), which expresses the change in total costs in relation to the change in quantity of the resource. These additional costs from hiring one more unit of labor is the wage rate (PL). A profit maximizing firm will want to hire another worker if the additional revenues generated exceed the additional costs, hence MRPL > PL. If MRPL < PL, that means for a company, hiring more workers adds more to the cost than to the revenues. Consequently a profit maximizing firm will hire the optimal amount of labor where the MRPL of the last worker equals the changes of the cost due to his hiring, expressed by the market wage rate PL, accordingly MRPL = PL.

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