Question

How is the optimal amount of labour determined in a perfectly competitive market?

Answer 1

A profit maximising firm will employ labour up to the point where the extra cost incurred by employing the last unit of labour (wage) equals the additional benefit it earns by employing that unit of labour.

That is, Marginal cost of labour = Marginal benefit by labour

Or, Wage rate = Marginal Revenue Product

Or, w = MRP_L

Or, w = MR × MP_L (as MRP_L = MR × MP_L)

Or, w = P × MP_L (in Perfect competition Price = MR)

Or, w = VMP_L (because VMP_L = P × MP_L)

The demand for labour is derived from VMP_L and the supply of labour is positively sloped. The equilibrium exists at E, where the demand for labour and the supply of labour intersect each other. The equilibrium wage rate is w and optimal amount of labour is q_L.