Chapter 4: Labor Demand Elasticities

1. Chapter 4: Labor Demand Elasticities

2. Own-wage Elasticity of Labor Demand Labor demand is said to be:

3. Elasticity and Slope • Slope involves a relationship between the change in the level of the wage and a change in the level of employment. Elasticity involves a relationship between percentage changes in these variables. • A constant change in the level of a variable will not result in a constant percentage change in that variable.

4. Elasticity and Slope Note, for example that: • an increase from 1 to 2 is a 100% increase, • an increase from 2 to 3 is a 50% increase, • an increase from 3 to 4 is a 33% increase, • an increase from 4 to 5 is a 25% increase, • an increase from 10 to 11 is a 10% increase, and • an increase from 100 to 101 is a 1% increase.

5. Elasticity Along a Linear Demand Curve

6. Elasticity Along a Linear Demand Curve

7. Elasticity and Slope Comparisons

8. Determinants of Own-wage Elasticity of Labor Demand • the substitution effect is larger, and/or • the scale effect is larger Labor demand will be more elastic when:

9. Hicks-Marshall Laws of Derived Demand Own-wage elasticity of labor demand is relatively high when: • the price elasticity of demand for the final product is relatively high, • tt is relatively easy to substitute other factors for this category of labor, • the supply of other factors of production is relatively elastic, and • this category of labor accounts for a relatively large share of total costs.

10. First Hicks-Marshall Law • Own-wage elasticity of demand is relatively high when the price elasticity of demand for the final product is relatively high. • This works through the scale effect: • Higher wages result in higher average and marginal costs, • Higher costs result in a higher product price, • Higher prices result in a reduction in the quantity of the product demanded, • A reduction in sales results in a reduction in output and in input use.

11. Second Hicks-Marshall Law • Own-wage elasticity of labor demand will be relatively high when it is relatively easy to substitute other factors for this category of labor. • This law works through the substitution effect.

12. Third Hicks-Marshall Law • Own-wage elasticity of labor demand is relatively high when the price elasticity of supply is relatively high for other factors of production. • This law works through the substitution effect.

13. Fourth Hicks-Marshall Law • Own-wage elasticity is relatively large when this category of labor accounts for a relatively large share of total costs • This law works through the scale effect: • Higher wages result in higher average and marginal costs, • Higher costs result in a higher product price, • Higher prices result in a reduction in the quantity of the product demanded, • A reduction in sales results in a reduction in output and in input use.

14. Hicks-Marshall Laws and Union Strategy • unions will be more successful in receiving wage increases in markets in which labor demand is relatively inelastic, • unions will attempt to reduce the own-wage elasticity of demand for their workers, and • unions might prefer to organize those labor markets in which labor demand is relatively inelastic.

15. Hicks-Marshall Laws and Union Strategy • price elasticity of demand for the final product, • ease of substitution of other inputs, • supply elasticity of other inputs, • labor’s share of total costs.

16. Cross-wage (Cross-price) Elasticity of Demand • A positive cross-price elasticity of demand between two inputs indicates that the two inputs are gross substitutes. • Two inputs are gross complements if the cross-price elasticity is negative.

17. Empirical Estimates of Cross-wage Elasticities • labor and energy are substitutes, • labor and materials are substitutes, • skilled workers are more likely to be gross complements with capital than are unskilled workers, and • there is little complementarity or substitution between immigrant and native workers.

18. Minimum Wage Effects • minimum wages are specified in nominal, not real terms. • employment reduction under perfect competition and complete coverage

19. Minimum Wage Effects - Noncovered Sector

20. Minimum wage (or union) in a monopsony

21. Summary of Minimum Wage Theory A minimum wage is expected to result in: • unemployment and economic inefficiency if the labor market is perfectly competitive and there is complete coverage, • economic inefficiency if the labor market is perfectly competitive and there is a non-covered sector, and • an ambiguous effect on the level of employment if firms possess some degree of monopsony power.

22. Empirical Results • early studies suggested a negative effect on teenage unemployment, • recent studies suggest little or no impact, • effect on poverty is limited (only 22% of minimum wage workers live in households with income below the poverty level).

23. Technological Change • lower cost and higher quality products, • shifts in pattern of labor demand, • automation is approximately equivalent to a reduction in the price of capital -- thus, it results in substitution and scale effects, • no evidence of increased aggregate unemployment due to technological change.