The correct option is It increases because the Value of Marginal Product (VMP) increases.
Explanation
In economics, the demand for labour is considered a derived because it stems from the demand for the final goods and services that labour produces. In a perfectly competitive market, a profit-maximizing firm determines its demand for labour based on the Value of Marginal Product (VMP).
Detailed Analysis:
- Understanding VMP: The Value of Marginal Product (VMP) represents the additional revenue a firm generates by hiring one more unit of labour. It is calculated as the Marginal Product of Labour ($MP_L$) multiplied by the Price of the commodity ($P$).
Formula: $VMP_L = MP_L \times P$ - Impact of Price Rise: If the price ($P$) of the commodity increases, the value of what each worker produces ($VMP_L$) increases, assuming physical productivity ($MP_L$) remains constant.
- Shift in Labour Demand: The labour demand curve corresponds to the downward-sloping portion of the VMP curve. Therefore, when $P$ rises, the VMP curve shifts outward (to the right). This means that at any given wage rate, the firm finds it profitable to hire more workers.
Option Analysis:
- It decreases because production becomes costlier. is Incorrect: An increase in the price of the output increases the firm's potential revenue, incentivizing an expansion in production rather than making it "costlier" in a way that reduces labour demand.
- It increases because the Value of Marginal Product (VMP) increases. is Correct: A higher commodity price directly increases the VMP, which shifts the demand curve for labour to the right, resulting in increased demand.
- It remains unchanged as labour demand depends only on wages. is Incorrect: The demand for labour is determined by both the wage rate (movement along the curve) and the VMP (shift of the curve). It is not dependent on wages alone.
- It becomes perfectly elastic. is Incorrect: Perfect elasticity implies a horizontal demand curve. A change in the commodity price shifts the position of the demand curve but does not necessarily change its elasticity to become perfect.
Key Takeaway:
Labour demand is positively correlated with the price of the good produced. An increase in the product's price raises the Value of Marginal Product (VMP), leading to an increase in the demand for labour.