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Suppose that a firm is competitive in both the product market and the labor market.  If the market determined wage rate decreases, the firm's demand for labor increases.  Explain why using the marginal productivity theory of input demand.
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Modern Labor Economics: Theory and Public Policy
Edition: 12th
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At the initial employment level, marginal revenue product equals the wage rate.  When the wage decreases, MRP > W at the initial employment level.  Given a negatively sloped MRP curve, there are now additional workers that add more to revenue than to cost.  The firm should employ each additional worker for whom MRP exceeds W.  As the firm expands employment in this fashion, however, MRP is reduced via diminishing marginal returns and expansion in employment stops at the point where MRP is equal to the new wage.  In essence, labor demand increases in this case because a drop in the wage rate implies that the contribution to revenue exceeds the contribution to cost for a larger number of workers.  It is profitable for the firm to employ every worker that contributes more to revenue than to cost.
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