15.3 : The Competitive Profit Maximizing Firm's Demand for Labor: Assumptions

To analyze the demand for labor by a firm, several key assumptions are made.

First, it is assumed that the goal of the firm is to maximize its profits.

Next, is the assumption of the law of diminishing marginal product. It means that, as the firm hires additional units of labor, each subsequent worker contributes less to the overall output than the previous one. For example, in a factory, the first worker may produce a substantial number of units, but each additional worker will contribute fewer units as the factory becomes increasingly crowded and capital inputs become scarcer.

Labor homogeneity is another assumption. This means that all workers are considered identical in terms of skills and productivity. The firm views each laborer as interchangeable, with no preference for one worker over another based on experience or specific skills.

Furthermore, the product market is assumed to be perfectly competitive. In such a market, there are numerous buyers and sellers of the product, ensuring that no single firm can influence the market price of the product.

Similarly, the labor market is also assumed to be perfectly competitive. Numerous firms are vying to hire workers, and many laborers are seeking employment. Because many other firms are hiring workers, a single firm cannot influence the wage paid to workers.

In the current analysis, the firm is assumed to be operating in the short run with only one variable input, which is labor.