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Labor demand curve maps qty. of labor demanded to employer wage Labor supply curve maps qty. of labor supplied to employee wage When employee wage = employer wage, two curves share a vertical axis, be plotted together. Distortions W(eme) = W(emr) = Wage L(S) to W(eme) L(D) to W(emr)

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Distortions l.jpg

Labor demand curve maps qty. of labor demanded to employer wage

Labor supply curve maps qty. of labor supplied to employee wage

When employee wage = employer wage, two curves share a vertical axis, be plotted together.

Distortions

W(eme) = W(emr) = Wage

L(S) to W(eme)

L(D) to W(emr)


Distortions2 l.jpg

When employee wage wagedoes not equal employer wage, there is a distortion in the labor market.

What employers pay to acquire labor does not equal what employees get for supplying labor.

Labor supply and demand curves do not share an axis, cannot be plotted together.

Distortions

Which wage?

L(S) to W(eme)

L(D) to W(emr)


Distortions3 l.jpg

Problem fixed by drafting new labor supply curve that maps quantity of labor supplied to employer wage.

Find out how to convert employer wage to employer wage

Convert employee wages on labor supply curve to employer wages

Use converted labor supply curve to find equilibrium

Distortions

Which wage?

L(S) to W(eme)

L(D) to W(emr)


Distortions4 l.jpg

Ex.: A 10% wage tax quantity of labor supplied to

Employer wage about 10% above employee wage.

Employee wages can be converted to employer wages by simply moving up the graph by about 10%

Labor supply curve that maps employee wage can be converted to one that maps employer wage by moving it up graph by 10%

Distortions

L(S) to W(emr)

Which wage?

L(S) to W(eme)

10%

L(D) to W(emr)


Distortions5 l.jpg

Ex.: A 10% wage tax quantity of labor supplied to

We now have curves that tell us what L(S) and L(D) is at each employer wage.

We know the employer wage where L(S) = L(D): equilibrium employer wage.

Since employer wage about 10% greater than employee wage, equilibrium employee wage about 10% less than equilibrium employer wage.

Distortions

L(S) to W(emr)

Employer

wage

L(S) to W(eme)

10%

W(emr)*

10%

W(eme)*

L(D) to W(emr)

L(S) =

L(D) =

L*


Distortions6 l.jpg

Ex.: A 10% wage tax quantity of labor supplied to

Employer surplus (blue) equals the area above the equilibrium employer wage and below the labor demand curve.

Employee surplus (green) equals the area below the equilibrium employee wage and above the old, employee-wage labor supply curve.

Distortions

L(S) to W(emr)

Employer

wage

L(S) to W(eme)

10%

W(emr)*

10%

W(eme)*

L(D) to W(emr)

L(S) =

L(D) =

L*


Distortions7 l.jpg

Without tax: quantity of labor supplied to

Find equilibrium using old L(S), L(D) curves

Equilibrium employer wage is lower

Equilibrium employee wage is higher

Equilibrium quantity of labor transacted is greater

Employer surplus greater

Employee surplus greater

Distortions

L(S) to W(emr)

Employer

wage

L(S) to W(eme)

W(emr)*

W(no tax)*

W(eme)*

L(D) to W(emr)

L* L*(no tax)


Distortions8 l.jpg

Ex.: A 10% wage tax quantity of labor supplied to

Total surplus is lower because of tax

Some of lost total surplus made up by government revenue from tax collections (yellow)

Some of lost total surplus is not (red), called “dead weight loss”

Distortions

L(S) to W(emr)

Employer

wage

L(S) to W(eme)

W(emr)*

W(no tax)*

W(eme)*

L(D) to W(emr)

L* L*(no tax)


Distortions9 l.jpg

Ex.: A 10% wage tax quantity of labor supplied to

Total surplus is lower because of tax

Some of lost total surplus made up by government revenue from tax collections (yellow)

Some of lost total surplus is not (red), called “dead weight loss”

Distortions

L(S) to W(emr)

Employer

wage

L(S) to W(eme)

W(emr)*

W(no tax)*

W(eme)*

L(D) to W(emr)

L* L*(no tax)


The elasticity of labor demand l.jpg

Elasticity of labor demand measures sensitivity of qty. of labor demanded to employer wage.

If employers reduce hiring by a lot when wage they must pay increases, then labor demand is elastic.

If employers reduce hiring by only a little, then labor demand is inelastic.

The Elasticity of Labor Demand

W(emp)

L(D)

L(D)

L(D) elastic

W(emp)

L(D)

L(D)

L(D) inelastic


The elasticity of labor demand11 l.jpg

The larger the scale and substitution effects, the greater the elasticity

If increase in wage results in large increase in firms’ production costs, then firms will reduce hiring by a lot.

If increase in wage results in firms substituting other kinds of labor or capital to do same work, then firms will reduce hiring by a lot.

The Elasticity of Labor Demand

W(emp)

L(D)

L(D)

L(D) elastic

W(emp)

L(D)

L(D)

L(D) inelastic


The hicks marshall conditions l.jpg

A famous result about the determinants of the elasticity of labor demand are the Hicks-Marshall conditions of derived demand.

Alfred Marshall, Principles of Economics (1890)

John Hicks, The Theory of Wages (1943)

The Hicks-Marshall Conditions

W(emp)

L(D)

L(D)

L(D) elastic

W(emp)

L(D)

L(D)

L(D) inelastic


The hicks marshall conditions13 l.jpg

1. The more substitutable the labor, the greater the elasticity of labor demand.

If employee wage increases, firms have option of hiring substitute kinds of labor, capital, etc.

The easier substitution will be, the more likely firms will do it, the greater the reduction in firms hiring.

The Hicks-Marshall Conditions

W(emp)

L(D)

L(D)

L(D) elastic

W(emp)

L(D)

L(D)

L(D) inelastic


The hicks marshall conditions14 l.jpg

Ex.: Suppose the wages of union workers increase. elasticity of labor demand.

Employers may say: “The union guys are great, there’s no substitute for them, I’ll still hire them, they’re worth it.” L(D) is inelastic.

Or: “Why should I pay that much more for union guys? The nonunion guys are just as good. I’m switching to them.” L(D) is elastic.

The Hicks-Marshall Conditions

W(emp)

L(D)

L(D)

L(D) elastic

W(emp)

L(D)

L(D)

L(D) inelastic


The hicks marshall conditions15 l.jpg

2. The greater the supply elasticity of substitutes, the greater the elasticity of labor demand.

Increase in wage increases demand for substitutes

Increase in demand bids up wage/price of substitutes, reduces substitutes’ appeal

Greater substitute supply elasticity, smaller the effect

The Hicks-Marshall Conditions

W(emp)

L(D)

L(D)

L(D) elastic

W(emp)

L(D)

L(D)

L(D) inelastic


The hicks marshall conditions16 l.jpg

2. Ex.: Suppose the wages of union workers increase. greater the elasticity of labor demand.

Firms subst. nonunioners

Demand for nonunion workers increases.

Small elasticity of labor supply of nonunion workers = increase in demand vastly bids up nonunion wage

Nonunion less appealing, union workers still hired, L(D) inelastic.

The Hicks-Marshall Conditions

W(emp)

L(D)

L(D)

L(D) elastic

W(emp)

L(D)

L(D)

L(D) inelastic


The hicks marshall conditions17 l.jpg

2. Ex.: Suppose the wages of union workers increase. greater the elasticity of labor demand.

Firms subst. nonunioners

Demand for nonunion workers increases.

Large elasticity of labor supply of nonunion workers = increase in demand hardly bids up nonunion wage

Nonunion still appealing substitute, union workers get cut, L(D) elastic*.

The Hicks-Marshall Conditions

W(emp)

L(D)

L(D)

L(D) elastic

W(emp)

L(D)

L(D)

L(D) inelastic


The hicks marshall conditions18 l.jpg

3. The greater the share of firms’ total costs paid to kind of labor, the greater elasticity of labor demand.

Greater the share of costs, greater the increase in firms’ total costs caused by wage increase.

Greater the increase in prices, greater decrease* in sales, greater decrease in need for all kinds of labor.

The Hicks-Marshall Conditions

W(emp)

L(D)

L(D)

L(D) elastic

W(emp)

L(D)

L(D)

L(D) inelastic


The hicks marshall conditions19 l.jpg

3. Ex.: Suppose the wages of union workers increase. kind of labor, the greater elasticity of labor demand.

If cost of hiring union workers only 1% of total cost, then firms’ total production cost increases by only a little.

Firms increase their prices by only a little, lose few customers, barely decrease production, let few union workers go. L(D) inelastic.

The Hicks-Marshall Conditions

W(emp)

L(D)

L(D)

L(D) elastic

W(emp)

L(D)

L(D)

L(D) inelastic


The hicks marshall conditions20 l.jpg

3. Ex.: Suppose the wages of union workers increase. kind of labor, the greater elasticity of labor demand.

If cost of hiring union workers is 100% of total cost, then firms’ total production cost increases by a lot.

Firms increase their prices a lot, lose many customers, seriously cut production, let many union workers go. L(D) elastic.

The Hicks-Marshall Conditions

W(emp)

L(D)

L(D)

L(D) elastic

W(emp)

L(D)

L(D)

L(D) inelastic


The hicks marshall conditions21 l.jpg

4. The greater the product demand elasticity, the greater the elasticity of labor demand.

Increase in wage increases firms’ total costs, prices

Greater product demand elasticity, greater sales drop caused by price increase

Greater sales drop, greater decrease in need for labor.

The Hicks-Marshall Conditions

W(emp)

L(D)

L(D)

L(D) elastic

W(emp)

L(D)

L(D)

L(D) inelastic


The hicks marshall conditions22 l.jpg

4. Ex.: Suppose the wages of union workers increase. the elasticity of labor demand.

Increase in wage increases firms’ total costs, prices

If product demand elasticity is slight, then people gladly pay higher prices, do not buy fewer goods.

Firms still need as many workers as before, do not cut workers. L(D) inelastic.

The Hicks-Marshall Conditions

W(emp)

L(D)

L(D)

L(D) elastic

W(emp)

L(D)

L(D)

L(D) inelastic


The hicks marshall conditions23 l.jpg

4. Ex.: Suppose the wages of union workers increase. the elasticity of labor demand.

Increase in wage increases firms’ total costs, prices

If product demand elasticity is great, then people unwilling to pay higher prices, buy fewer goods.

Firms don’t need as many workers as before, cut workers. L(D) elastic.

The Hicks-Marshall Conditions

W(emp)

L(D)

L(D)

L(D) elastic

W(emp)

L(D)

L(D)

L(D) inelastic


The hicks marshall conditions24 l.jpg

Conditions 1-2 deal with substitution effect, 3-4 deal with scale effect.

Conditions 1, 2, and 4 theoretically hold under standard economic assumptions, 3 requires more restrictive assumptions.

The Hicks-Marshall Conditions

W(emp)

L(D)

L(D)

L(D) elastic

W(emp)

L(D)

L(D)

L(D) inelastic


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