Question

In a perfectly competitive market, the demand curve for labor a. slopes upward. b. slopes downward because of diminishing marginal productivity. c. is perfectly elastic at the equilibrium wage rate. d. is described by all of the above.

Short answer

In a perfectly competitive market, the demand curve for labor is perfectly elastic at the equilibrium wage rate. This is because, in this market, firms have no power to influence the wage rate and must accept the market wage rate as given. The demand curve for labor also slopes downward due to diminishing marginal productivity, as the revenue generated by the marginal worker decreases as more workers are hired. Thus, the correct answer is option c.

Step-by-step solution

Option a: Slopes upward

The demand curve for labor in a market does not typically slope upward. In general, when the wage rate (price of labor) increases, firms would hire fewer workers due to the higher cost. As a result, the labor demand curve would slope downward, not upward. Therefore, option a is incorrect.

Option b: Slopes downward due to diminishing marginal productivity

In a perfectly competitive labor market, firms will hire more workers up to the point where the marginal productivity of the workers matches the wage rate. Essentially, firms would continue hiring until the additional revenue generated by hiring an additional worker equals the wage rate. Due to diminishing marginal productivity, the revenue generated by the marginal worker would decrease as more workers are hired. Consequently, the labor demand curve slopes downward. Option b is correct.

Option c: Perfectly elastic at the equilibrium wage rate

In a perfectly competitive labor market, there are many firms hiring workers, and the workers are homogeneous (identical). As a result, the individual firm would have no power to influence the wage rate and must accept the market wage rate as given. If the wage rate were above the equilibrium, there would be an excess supply of labor; in contrast, if the wage rate were below the equilibrium, there would be a labor shortage. At the equilibrium wage rate, all the firms can hire as many workers as they want without affecting the wage rate. Thus, the demand curve for labor is perfectly elastic at the equilibrium wage rate. Option c is correct.

Option d: Described by all of the above

Based on the analysis carried out for options a, b, and c, we have determined that the demand curve for labor in a perfectly competitive market slopes downward due to diminishing marginal productivity and is perfectly elastic at the equilibrium wage rate. Therefore, option d is incorrect as it includes the incorrect statement that the labor demand curve slopes upward. Based on the analysis above, the correct answer is: c. The demand curve for labor in a perfectly competitive market is perfectly elastic at the equilibrium wage rate.

Key concepts

Labor Demand Curve

In a perfectly competitive labor market, the labor demand curve is an essential concept that helps us understand how firms decide on the number of workers to employ. The demand for labor is derived from the firm's aim to maximize profit. When firms demand more labor, they base this decision on their need to produce more goods and services.

However, as the wage rate increases, the cost of hiring additional workers also rises. This typically causes the labor demand curve to slope downward. This downward slope reflects that higher wages lead to fewer workers being hired, as firms seek to minimize costs. In essence, the labor demand curve shows the relationship between the wage rate and the number of workers demanded. It's crucial for understanding how changes in the economy or the firm's production needs affect employment.

Diminishing Marginal Productivity

Diminishing Marginal Productivity is a vital concept explaining why the labor demand curve slopes downward. As firms hire more workers, each additional worker contributes less to the total output than the previous one. This is because, while some resources like machinery, remain fixed, adding more workers means that each worker has less of the resource to use.

The concept reflects that at some point, the addition of more workers leads to overcrowding or overuse of resources, making additional workers less productive. Therefore, the marginal product—the additional output produced by one more worker—tends to decrease. Firms will continue adding workers only until this marginal product equals the wage rate, ensuring they maximize their profits. Beyond this point, hiring more workers is not economically justified.

Equilibrium Wage Rate

The equilibrium wage rate is the wage at which the labor supply and demand are equal. In a perfectly competitive market, this is where the wage rate settles naturally. At the equilibrium wage, firms find the cost of labor acceptable, and workers are willing to provide their labor.

At this wage rate, the market reaches a balance where there is neither a surplus nor a shortage of labor. If wages were above this level, a surplus would cause firms to hire less, eventually pushing wages back down. Conversely, if wages were below the equilibrium, a shortage would lead firms to bid up wages to attract more workers. Thus, the equilibrium wage rate is crucial for balance and stability in the labor market.

Elasticity of Demand

Elasticity of demand in the labor market refers to how responsive the quantity of labor demanded is to a change in the wage rate. In perfectly competitive markets, the demand for labor is often said to be perfectly elastic at the equilibrium wage rate.

This characteristic means that at a specific wage rate, firms can hire any number of workers without affecting the wage. If firms attempt to pay less than the market wage, they risk losing workers to competitors, because in a competitive market, workers seek the best compensation for their labor. On the other hand, if they pay more, they will not necessarily attract more workers, but rather incur higher costs. Therefore, understanding elasticity helps firms and workers make informed decisions about hiring and wages.