Job Creation at the Microeconomic Level
Firms decide to create or lose jobs based on the price of output, the price of inputs, and the marginal productivity of inputs. Firms will continue to demand labor until the marginal revenue product of labor equals the wage rate - that is, until the marginal benefit of one more employee equals the marginal cost of that employee. For example, suppose a shoe factory can sell shoes for $50 a pair, and hiring an additional employee to work for an hour allows the factory to produce one extra pair of shoes. As long as the wage rate is less than $50/hour, the firm can increase its profit by hiring more worker and producing more shoes. Eventually, however, the factory will become crowded, workers will need to wait in line for access to necessary tools and machinery, or the supply of materials will fail to keep up with the production pace. This will cause the marginal productivity of labor to fall, so that an additional hour of work produces less than one extra pair of shoes. If the prevailing wage rate is $25/hour, the firm will hire until it takes two hours of work to produce one pair of shoes. At this point, the marginal benefit of hiring labor is $25, equal to the marginal cost.
Factors that increase the productivity of labor will increase demand for labor and create jobs. Suppose a new type of sewing machine is invented that is smaller and allows shoemakers to work more quickly. This increases the productivity of labor, so that at its previous employment levels the firm can now earn $35 for every hour of labor it employs. Just as before, the firm will create more jobs and continue to hire until the marginal revenue product of labor is again equal to the wage rate. Similarly, if the price of output rises firms will hire more employees. If the price of shoes increases to $60, for example, workers that were previously making $25 worth of shoes in an hour will be making $30 worth of shoes each hour instead. Since the wage rate is still $25, the firm will hire more workers until the marginal revenue product of labor is equal to the wage rate.
Job Creation at the Macroeconomic Level
At a macroeconomic level, jobs are created when the general level of output rises and jobs are destroyed when the general level of output falls. The quantity of labor employed and the wage rate are determined by the intersection of labor supply (the number of people willing to enter the workforce at any given wage) and the labor demand (the amount of labor producers are willing to employ at any given wage rate). Labor supply is based primarily upon the size of the population and therefore remains fairly stable. The labor demand, however, shifts to the left when an economy's output falls, since firms will need fewer workers to produce fewer goods. Likewise, labor demand shifts to the right when an economy's output rises. These shifts will destroy job and lower wages or create jobs and increase wages, respectively .
Output and Employment
As this hypothetical graph shows, when output (GDP) is rising, jobs are created and unemployment falls. When output is falling, jobs are destroyed and unemployment rises.
One reason that economic activity might rise or fall is the business cycle. The business cycle refers to the periods of expansions and contractions in the level of economic activities around the long-term growth trend. This is typically due to an increase or decrease in the economy-wide demand for consumer goods, but these cycles could also take place due to changes in production technology, changes in governmental policy, and many other factors.
At the macroeconomic level jobs may also shift between industries due to changes in demand or technology. For example, when health researchers uncovered facts about the health risks of smoking, the demand for cigarettes dropped and many jobs were lost in the tobacco industry. As for technology, the invention of the telephone created many jobs in telecommunications, but destroyed most of the jobs associated with telegraphs.