Why is the labor demand curve downward sloping like the demand curve for any other good or service?

1 Answer
Dec 20, 2015

Because, the higher the price of labor, the less workers the firm will be able to hire.


According to the neoclassic theory, the firms represent the demand for labor, as they need workers to produce goods. They will pay these workers a wage, so wages are the cost of labor. The higher this cost, the less workers the firms will be able to hire.

Just like any other demand curve, the higher the price of the good, the less quantities will be demanded. A firm with a given budget and a know revenue level cannot keep hiring employees forever, because, if it does so, it will start losing profits.

There is another issue: it is not the nominal wage (#w#) that matters for the companies and workers, but the real wage #w/p#, because both actors need to evaluate the current price level #p#. In an inflation scenario, #p# will increase, causing a reduction of real wages. When that happens, firms will demand more labor and workers will demand more leisure.