A Simple Graphical Example

Let's use these ideas to visualize the demand for labor. On this page, we will make one simplifying assumption: the price of the output (the price per bushel of potatos, for example) is held constant as the wage varies for an individual firm. (We'll see in the next page what difference the simplifying assumption makes).

We can visualize the VMP and the wage as in the following figure:

Figure 1: VMP=wage

As the wage drops from W₁ to W₂ and then to W₃, we see the demand for labor increasing from N₁ to N₂ and then to N₃. The firm is moving down the curve of diminishing marginal productivity, and the cheaper labor is, the more sense it makes to move further down that curve, and the further down the curve the profit-maximizing labor input is.

What this is telling us is that (with the output price constant) the VMP curve is the firm's demand curve for labor. Remember the definition of a demand curve: it tells us, for each price, what will be the quantity demanded. The price of labor is the wage, and the VMP curve tells us, for each wage, what is the quantity of labor demanded.