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In: Economics

Parting from the profit maximizing rule, why is W = VMP = demand for labor? Would...

Parting from the profit maximizing rule, why is W = VMP = demand for labor?

Would a union agreement preventing firms from substituting capital for labor make labor-demand elasticity more or less elastic? Why?

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Expert Solution

Question 1

VMP or Value of Marginal Product is calculated by multiplying the marginal product by price of the product.

VMP indicates the increase in total revenue of the firm when it hires one more worker.

Wage rate implies the income paid to workers. So, wage rate paid to one more worker hired implies an increase in total of the firm as one more worker is hired.

A firm maximizes profit when it hires that quantity of labor corresponding to which increase in total revenue as one more worker is hired equals the increase in total cost as one more worker is hired.

Increase in total revenue as one more worker is hired indicates VMP while increase in total cost as one more worker is hired indicates wage rate.

So,

The profit-maximizing quantity of labor hired is that quantity corresponding to which VMP equals wage rate.

Quantity of labor hired implies demand for labor.

Therefore,

W = VMP = Demand for Labor

Rahul Sunny answered 1 year ago
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