The equilibrium quantity of labor used in the production of a good will be the largest under which of the following conditions?

• A. When both the labor and output markets are perfectly competitive
• B. When only the labor market is perfectly competitive
• C. When both markets are unregulated monopolies
• D. When the output market is a monopoly

Answer: (A)

When both the labor and the output markets are perfectly competitive, there is no market power to distort prices. A firm hires labor up to the point where the wage equals the value of the marginal product of labor (w = MRP). In a perfectly competitive output market, the value of the marginal product equals the price of the good times the marginal product of labor (MRPL = P × MPL). Because there’s no monopoly markup shrinking MR, MRPL is as large as possible for each level of labor, so the firm’s demand for labor is strongest. This pushes the equilibrium quantity of labor higher than in scenarios with monopolized output or labor markets, where MR is reduced or wages are less responsive, respectively. Therefore, the largest employment occurs when both markets are perfectly competitive.