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Chapter 4Chapter 4
Labor Demand ElasticitiesLabor Demand Elasticities
Own Wage ElasticityOwn Wage Elasticity
iiii = (% = (% LLi i ) / (% ) / (% wwi i ))
If:If: Then:Then:
iiii| > 1 | > 1 labor demand is elasticlabor demand is elastic
iiii| < 1 | < 1 labor demand is inelasticlabor demand is inelastic
iiii| = 1 | = 1 labor demand is unit elasticlabor demand is unit elastic
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In general, the flatter the demand curve, the more elastic it is
However, elasticity is NOT However, elasticity is NOT constant along a linear constant along a linear
demand curvedemand curve..
Along a linear demand curve, demand is Along a linear demand curve, demand is very elastic at high levels of the wage very elastic at high levels of the wage
and then becomes more inelastic as the and then becomes more inelastic as the wage falls (moving down and to the right wage falls (moving down and to the right
along the demand curve)along the demand curve)
Aggregate EarningsAggregate Earnings
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DL
w
8
200
Aggregate Earnings = wL
AE = ($8)(200)
AE = $1600
What happens to aggregate What happens to aggregate earnings as the wage earnings as the wage
changes?changes? When the wage rises, the quantity of labor hired When the wage rises, the quantity of labor hired
fallsfalls
AE = w LAE = w L
When the wage falls, the quantity of labor hired When the wage falls, the quantity of labor hired
risesrises
AE = w LAE = w L
So, what happens to AE?So, what happens to AE?
What happens to aggregate What happens to aggregate earnings as the wage earnings as the wage
changes?changes?If labor demand is elastic:If labor demand is elastic:
iiii| > 1| > 1
|% |% LLii|| / |% / |% wwi i | > 1| > 1
|% |% LLi i | > |% | > |% wwi i ||
If wIf w and L and L, AE will , AE will If w If w and L and L , AE will , AE will
What happens to aggregate What happens to aggregate earnings as the wage earnings as the wage
changes?changes?If labor demand is inelastic:If labor demand is inelastic:
iiii| < 1| < 1
|% |% LLi i | / |% | / |% wwi i | < 1| < 1
|% |% LLi i | < |% | < |% wwi i ||
If wIf w and L and L, AE will , AE will
If w If w and L and L, AE will , AE will
What happens to aggregate What happens to aggregate earnings as the wage earnings as the wage
changes?changes?If labor demand is unit elastic:If labor demand is unit elastic:
iiii| = 1| = 1
|% |% LLi i | / |% | / |% wwi i | = 1| = 1
|% |% LLi i | = |% | = |% wwi i ||
If wIf w and L and L, AE will not change , AE will not change
If w If w and L and L, AE will not change, AE will not change
What determines the elasticity of What determines the elasticity of labor demand?labor demand?
The Hicks-Marshall Laws of Derived The Hicks-Marshall Laws of Derived DemandDemand summarize four rules about the summarize four rules about the elasticity of demand for inputselasticity of demand for inputs
The demand for labor will be more The demand for labor will be more ElasticElastic (larger in absolute value): (larger in absolute value):
the more Elastic is the demand for the final the more Elastic is the demand for the final product,product,
the easier it is for firms to substitute other the easier it is for firms to substitute other inputs for this category of labor,inputs for this category of labor,
the more Elastic the supply of other the more Elastic the supply of other (substitutable) factors of production (substitutable) factors of production
the greater the proportion of labor cost to total the greater the proportion of labor cost to total production cost (NOTE: special case)production cost (NOTE: special case)
(1) The demand for labor will (1) The demand for labor will be more be more ElasticElastic when the when the
demand for the final product is demand for the final product is ElasticElastic..
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Elasticity of Demand for OutputS0
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Elasticity of Demand for OutputS0S1
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Elasticity of Demand for OutputS0S1
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Elasticity of Demand for OutputS0S1
This works through a This works through a scalescale effect effect As the wage rises, the cost of production As the wage rises, the cost of production
risesrises Firms will try to pass off the increase in cost Firms will try to pass off the increase in cost
to consumers by raising the price of the to consumers by raising the price of the productproduct
As PAs P, Q, Qdd. This means that the firm will . This means that the firm will decrease output and will need to decrease decrease output and will need to decrease employment of labor.employment of labor.
The amount of reduction in QThe amount of reduction in Qdd depends on depends on the elasticity of demand for the productthe elasticity of demand for the product
This implies that a firm's demand This implies that a firm's demand for labor will be more for labor will be more ElasticElastic than than the industry's demand for labor. the industry's demand for labor.
WHY?WHY? Because a firm’s product has more Because a firm’s product has more
close substitutes (products from similar close substitutes (products from similar firms) than an industry’s productfirms) than an industry’s product
This means that the elasticity of This means that the elasticity of demand for a firm’s product will be demand for a firm’s product will be largerlarger
This also implies that a firm's This also implies that a firm's demand for labor will be more demand for labor will be more
ElasticElastic in the in the long runlong run than in the than in the short run.short run.
WHY?WHY? Because the demand for a product is Because the demand for a product is
more Elastic in the long run than the more Elastic in the long run than the short run (it takes time for people to short run (it takes time for people to adjust their spending habits)adjust their spending habits)
This also implies that the This also implies that the more more competitivecompetitive a product market, a product market,
the more the more ElasticElastic the demand for the demand for labor.labor.
WHY?WHY? Competitive markets have many firms Competitive markets have many firms
selling very similar productsselling very similar products The more substitutes a product has, the The more substitutes a product has, the
more elastic its demandmore elastic its demand
Can this be used to explain Can this be used to explain where unions will organize?where unions will organize?
(2) the (2) the EASIEREASIER it is for firms it is for firms to substitute other inputs for to substitute other inputs for
this category of laborthis category of labor
Pilots and doctors face inelastic Pilots and doctors face inelastic demand curves for their services in demand curves for their services in the short run because of the limited the short run because of the limited possibilities of substituting machines possibilities of substituting machines or other workers for their servicesor other workers for their services..
When substitution is difficult, there are When substitution is difficult, there are few alternatives to employing these few alternatives to employing these
workers beyond going out of workers beyond going out of business.business.
Substitution possibilities may Substitution possibilities may be restricted by the production be restricted by the production process, by union rules, or by process, by union rules, or by
the government.the government.
(3) the more (3) the more ElasticElastic the the supply of other (substitutable) supply of other (substitutable)
factors of production factors of production
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C Elasticity of Supply of Other Factors
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CElasticity of Supply of Other Factors
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C Elasticity of Supply of Other Factors
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C Elasticity of Supply of Other Factors
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C Elasticity of Supply of Other Factors
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.. As the wage rate increases, firms may As the wage rate increases, firms may
wish to substitute capital for labor. wish to substitute capital for labor. This implies that the demand for capital This implies that the demand for capital
will rise.will rise. If the supply of capital is If the supply of capital is INelasticINelastic, the , the
price of capital will rise more than it price of capital will rise more than it would if the supply of capital is would if the supply of capital is ElasticElastic
Thus, although it may be Thus, although it may be technologically feasible to use technologically feasible to use more capital, economically it more capital, economically it
may not.may not.
(4) the greater the proportion of (4) the greater the proportion of labor cost to total production cost labor cost to total production cost
(NOTE: special case)(NOTE: special case)
The actual impact of a wage The actual impact of a wage increase on production costs increase on production costs depends on how high labor depends on how high labor
costs are relative to the other costs are relative to the other costs of production. costs of production.
What proportion of total costs are What proportion of total costs are wages?wages?
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Proportion of Total Costs
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We often say this is the We often say this is the importance of being importance of being
unimportant.unimportant.
Estimates of own-wage elasticities Estimates of own-wage elasticities are provided in Table 4.1 in your are provided in Table 4.1 in your
textbooktextbook
Estimates for long-run labor Estimates for long-run labor demand generally are close to demand generally are close to
unity.unity.
Using what we know about Using what we know about elasticity and the Hicks-Marshall elasticity and the Hicks-Marshall Laws of Derived Demand, what Laws of Derived Demand, what
can we predict about union can we predict about union behavior?behavior?
We can predict that:We can predict that:
unions will be more successful in markets unions will be more successful in markets where the demand for labor is more inelasticwhere the demand for labor is more inelastic
unions will attempt to make the demand for unions will attempt to make the demand for their members more inelastictheir members more inelastic
unions might first try to organize in markets unions might first try to organize in markets where the demand for labor is inelasticwhere the demand for labor is inelastic
Cross-Wage ElasticityCross-Wage Elasticity
jkjk = (% = (%LLjj) / (% ) / (% wwkk) )
If:If: Then the 2 inputs are: Then the 2 inputs are:
jkjk > 0 > 0 gross gross substitutessubstitutes
jkjk < 0 gross < 0 gross complementscomplements
What happens to the demand for adult workers if What happens to the demand for adult workers if the wage of teenage workers falls?the wage of teenage workers falls?
there will be both a there will be both a scale effectscale effect and a and a substitution effectsubstitution effect
production costs will fall; firm will want to production costs will fall; firm will want to produce more; hire more workers (both produce more; hire more workers (both teenagers and adults)teenagers and adults) demand for adult demand for adult workers will increase workers will increase (scale effect)(scale effect)
but, the relative price of adult workers has but, the relative price of adult workers has increased; firms will want to substitute relatively increased; firms will want to substitute relatively cheaper teenage labor for adult labor cheaper teenage labor for adult labor demand for adult workers will decrease demand for adult workers will decrease (substitution effect)(substitution effect)
The end result depends on The end result depends on which effect is larger.which effect is larger.
If the scale effect > substitution effect, the two If the scale effect > substitution effect, the two types of labor are gross complements; the types of labor are gross complements; the demand for adult labor demand for adult labor when the wage for when the wage for teenagers teenagers ; the cross-wage elasticity would be ; the cross-wage elasticity would be > 0> 0
If the substitution effect > scale effect, the two If the substitution effect > scale effect, the two types of labor are gross substitutes; the demand types of labor are gross substitutes; the demand for adult labor for adult labor when the wage for teenagers when the wage for teenagers ; the cross-wage elasticity would be < 0; the cross-wage elasticity would be < 0
What determines the strength What determines the strength of each of these effects?of each of these effects?
The scale effect will be large if:The scale effect will be large if:
the demand for the output is elasticthe demand for the output is elastic the share of total costs that teenage the share of total costs that teenage
labor accounts for is largelabor accounts for is large
The substitution effect will be largeThe substitution effect will be large IFIF::
teenage workers are easily substituted for teenage workers are easily substituted for adult workersadult workers
the supply of adult workers is inelasticthe supply of adult workers is inelastic teenagers account for a small proportion teenagers account for a small proportion
of total costsof total costs
What is believed aboutWhat is believed about CROSS-ELASTICITIESCROSS-ELASTICITIES::
labor and energy are substitutes (degree is labor and energy are substitutes (degree is small)small)
labor and materials are probably substitutes labor and materials are probably substitutes (degree is small)(degree is small)
skilled labor is likely to be a complement with skilled labor is likely to be a complement with capitalcapital
unskilled labor and capital are likely to be unskilled labor and capital are likely to be substitutessubstitutes
Policy ImplicationsPolicy Implications
The Effects of Minimum Wage The Effects of Minimum Wage LawsLaws
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So, is the demand for labor So, is the demand for labor Elastic or INelastic with respect to Elastic or INelastic with respect to
the minimum wage?the minimum wage?
Difficulties of studying the effects Difficulties of studying the effects of the minimum wage:of the minimum wage:
holding other things constantholding other things constant covered vs. uncovered sectorscovered vs. uncovered sectors
Figure 4.3Figure 4.3 Federal Minimum Wage: Level, and Relative to Federal Minimum Wage: Level, and Relative to
Wages in Manufacturing, 1938Wages in Manufacturing, 1938––20002000
Figure 4.4 Figure 4.4 Minimum Wage Effects: Minimum Wage Effects:
Growing Demand Obscures Job LossGrowing Demand Obscures Job Loss
Figure 4.5 Figure 4.5 Minimum Wage Effects: Minimum Wage Effects:
Incomplete Coverage Causes Incomplete Coverage Causes Employment ShiftsEmployment Shifts
What are the effects of What are the effects of technological change on the technological change on the
demand for labor?demand for labor?
There are two types of There are two types of technological change to consider:technological change to consider:
development of new productsdevelopment of new products automation (substituting capital for labor)automation (substituting capital for labor)
Development of New ProductsDevelopment of New Products
The invention of new products that take the The invention of new products that take the place of old may have large effects on laborplace of old may have large effects on labor
Workers producing the old products will see Workers producing the old products will see a decline in the demand for their labor a decline in the demand for their labor servicesservices
However, new jobs should be created with However, new jobs should be created with the firm (or firms) producing the new the firm (or firms) producing the new productsproducts
AutomationAutomation
This will likely have different effects on the This will likely have different effects on the markets for skilled and unskilled labormarkets for skilled and unskilled labor
Since skilled labor is probably a Since skilled labor is probably a complement, new capital products will likely complement, new capital products will likely lead to an increase in the demand for lead to an increase in the demand for skilled laborskilled labor
Since unskilled labor is probably a Since unskilled labor is probably a substitute, new capital products will likely substitute, new capital products will likely lead to a decrease in the demand for lead to a decrease in the demand for unskilled laborunskilled labor
In either case (new products In either case (new products or automation) the effects of or automation) the effects of technological change on total technological change on total employment in the economy employment in the economy
are likely to be positive.are likely to be positive.
