Read the case and answer the question.
A town has many identical bakeries that sell bread in a perfectly competitive market at Rs 20 a loaf. Each bakery hires workers by the hour, and the hourly wage is set in the town’s labour market. When a bakery hires one more hour of work, its output of bread rises, but each extra hour adds a little less bread than the hour before.
Suppose the hourly wage in the town rises while the price of bread stays at Rs 20. A bakery that wants to maximise profit will now:
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → employ fewer hours, because it must now work where the marginal product of labour is higher
A bakery hires up to where the wage equals VMPL (price × MPL). If the wage rises and the price stays at Rs 20, VMPL must rise, so MPL must be higher. Because each extra hour adds less bread, MPL is higher only when fewer hours are used.
Option (1) employ fewer hours, because it must now work where the marginal product of labour is higher — Correct. A higher MPL is reached by cutting back on hours.
Option (2) employ fewer hours, because the marginal revenue from bread falls when the wage rises — Incorrect. For a competitive bakery, MR equals the price of bread, which has not changed.
Option (3) employ the same hours, because the price of bread and its marginal revenue have not changed — Incorrect. With a higher wage, the old hours give VMPL less than the wage, so the last hours lower profit.
Option (4) employ more hours, because a higher wage raises the value of marginal product of labour — Incorrect. VMPL is price × MPL. The wage does not enter it, so a higher wage cannot raise it.
NCERT (2026-27): “Wage Determination in Labour Market … Given the assumption of the law of diminishing marginal product, the fact that the firm always produces at w = VMPL implies that the demand curve for labour is downward sloping. To explain why it is so, let us assume at some wage rate w1, demand for labour is l1. Now, suppose the wage rate increases to w2. To maintain the wage-VMPL equality, VMPL should also increase. The price of the commodity remaining constantb, this is possible only if MPL increases which in turn implies that less labour should be employed owing to the diminishing marginal productivity of labour. Hence, at higher wage, less labour is demanded thereby leading to a downward sloping demand, curve. To arrive at the market demand curve from individual firms’ demand curve, we simply add up the demand for labour by individual firms at different wages and since each firm demands less labour as wage increases, the market demand curve is also downward sloping.” |