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Chapter 4. Labor Demand Elasticities. Own Wage Elasticity.  ii = (%  L i ) / (% w i ) If: Then: | ii | > 1 labor demand is elastic | ii | < 1 labor demand is inelastic | ii | = 1 labor demand is unit elastic.

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Chapter 4

Chapter 4

Labor Demand Elasticities


Own wage elasticity
Own Wage Elasticity

ii = (% Li ) / (% wi )

If: Then:

|ii| > 1 labor demand is elastic

|ii| < 1 labor demand is inelastic

|ii| = 1 labor demand is unit elastic



However elasticity is not constant along a linear demand curve

However, elasticity is NOT constant along a linear demand curve.

Along a linear demand curve, demand is very elastic at high levels of the wage and then becomes more inelastic as the wage falls (moving down and to the right along the demand curve)


Aggregate earnings
Aggregate Earnings curve

w

S

Aggregate Earnings = wL

AE = ($8)(200)

AE = $1600

8

D

L

200


What happens to aggregate earnings as the wage changes
What happens to aggregate earnings as the wage changes? curve

  • When the wage rises, the quantity of labor hired falls

    AE = w L

     

  • When the wage falls, the quantity of labor hired rises

    AE = w L

    

    So, what happens to AE?


What happens to aggregate earnings as the wage changes1
What happens to aggregate earnings as the wage changes? curve

If labor demand is elastic:

|ii| > 1

|% Li| / |% wi | > 1

|% Li | > |% wi |

If w and L, AE will 

If w  and L , AE will 


What happens to aggregate earnings as the wage changes2
What happens to aggregate earnings as the wage changes? curve

If labor demand is inelastic:

|ii| < 1

|% Li | / |% wi | < 1

|% Li | < |% wi |

If w and L, AE will 

If w  and L, AE will 


What happens to aggregate earnings as the wage changes3
What happens to aggregate earnings as the wage changes? curve

If labor demand is unit elastic:

|ii| = 1

|% Li | / |% wi | = 1

|% Li | = |% wi |

If w and L, AE will not change

If w  and L, AE will not change


What determines the elasticity of labor demand
What determines the elasticity of labor demand? curve

  • The Hicks-Marshall Laws of Derived Demand summarize four rules about the elasticity of demand for inputs


The demand for labor will be more elastic larger in absolute value
The demand for labor will be more curveElastic (larger in absolute value):

  • the more Elastic is the demand for the final product,

  • the easier it is for firms to substitute other inputs for this category of labor,

  • the more Elastic the supply of other (substitutable) factors of production

  • the greater the proportion of labor cost to total production cost (NOTE: special case)


1 the demand for labor will be more elastic when the demand for the final product is elastic

(1) The demand for labor will be more curveElasticwhen the demand for the final product is Elastic.






  • This works through a curvescale effect

  • As the wage rises, the cost of production rises

  • Firms will try to pass off the increase in cost to consumers by raising the price of the product

  • As P, Qd. This means that the firm will decrease output and will need to decrease employment of labor.

  • The amount of reduction in Qd depends on the elasticity of demand for the product


This implies that a firm's demand for labor will be more curveElastic than the industry's demand for labor.

  • WHY?

  • Because a firm’s product has more close substitutes (products from similar firms) than an industry’s product

  • This means that the elasticity of demand for a firm’s product will be larger


This also implies that a firm's demand for labor will be more Elastic in the long run than in the short run.

  • WHY?

  • Because the demand for a product is more Elastic in the long run than the short run (it takes time for people to adjust their spending habits)


This also implies that the more competitive a product market the more elastic the demand for labor
This also implies that the more more competitive a product market, the more Elastic the demand for labor.

  • WHY?

  • Competitive markets have many firms selling very similar products

  • The more substitutes a product has, the more elastic its demand



2 the easier it is for firms to substitute other inputs for this category of labor

(2) the more EASIER it is for firms to substitute other inputs for this category of labor


Pilots and doctors face inelastic demand curves for their services in the short run because of the limited possibilities of substituting machines or other workers for their services.

When substitution is difficult, there are few alternatives to employing these workers beyond going out of business.


Substitution possibilities may be restricted by the production process, by union rules, or by the government.


3 the more elastic the supply of other substitutable factors of production

(3) the more production process, by union rules, or by the government.Elastic the supply of other (substitutable) factors of production


Elasticity of Supply of Other Factors production process, by union rules, or by the government.

SI

SE


Elasticity of Supply of Other Factors production process, by union rules, or by the government.

SI

SE

D0


Elasticity of Supply of Other Factors production process, by union rules, or by the government.

SI

SE

D1

D0


Elasticity of Supply of Other Factors production process, by union rules, or by the government.

SI

SE

D1

D0


Elasticity of Supply of Other Factors production process, by union rules, or by the government.

SI

SE

D1

D0


. production process, by union rules, or by the government.

  • As the wage rate increases, firms may wish to substitute capital for labor.

  • This implies that the demand for capital will rise.

  • If the supply of capital is INelastic, the price of capital will rise more than it would if the supply of capital is Elastic


Thus although it may be technologically feasible to use more capital economically it may not

Thus, although it may be technologically feasible to use more capital, economically it may not.


4 the greater the proportion of labor cost to total production cost note special case

(4) the greater the proportion of labor cost to total production cost (NOTE: special case)


The actual impact of a wage increase on production costs depends on how high labor costs are relative to the other costs of production.

What proportion of total costs are wages?


Proportion of Total Costs depends on how high labor costs are relative to the other costs of production.

S0


Proportion of Total Costs depends on how high labor costs are relative to the other costs of production.

S1

S0


Proportion of Total Costs depends on how high labor costs are relative to the other costs of production.

S1

S2

S0


We often say this is the importance of being unimportant

We often say this is the importance of being unimportant. depends on how high labor costs are relative to the other costs of production.


Estimates of own wage elasticities are provided in table 4 1 in your textbook

Estimates of own-wage elasticities are provided in Table 4.1 in your textbook

Estimates for long-run labor demand generally are close to unity.


Using what we know about elasticity and the Hicks-Marshall Laws of Derived Demand, what can we predict about union behavior?


We can predict that
We can predict that: Laws of Derived Demand, what can we predict about union behavior?

  • unions will be more successful in markets where the demand for labor is more inelastic

  • unions will attempt to make the demand for their members more inelastic

  • unions might first try to organize in markets where the demand for labor is inelastic


Cross wage elasticity
Cross-Wage Elasticity Laws of Derived Demand, what can we predict about union behavior?

hjk = (%Lj) / (% wk)

If: Then the 2 inputs are:

hjk > 0 gross substitutes

hjk < 0 gross complements


What happens to the demand for adult workers if the wage of teenage workers falls
What happens to the demand for adult workers if the wage of teenage workers falls?

  • there will be both a scale effect and a substitution effect

  • production costs will fall; firm will want to produce more; hire more workers (both teenagers and adults) demand for adult workers will increase (scale effect)

  • but, the relative price of adult workers has increased; firms will want to substitute relatively cheaper teenage labor for adult labor  demand for adult workers will decrease (substitution effect)


The end result depends on which effect is larger
The end result depends on which effect is larger. teenage workers falls?

  • If the scale effect > substitution effect, the two types of labor are gross complements; the demand for adult labor  when the wage for teenagers ; the cross-wage elasticity would be > 0

  • If the substitution effect > scale effect, the two types of labor are gross substitutes; the demand for adult labor  when the wage for teenagers ; the cross-wage elasticity would be < 0



The scale effect will be large if
The scale effect will be large if: teenage workers falls?

  • the demand for the output is elastic

  • the share of total costs that teenage labor accounts for is large


The substitution effect will be large if
The substitution effect will be large teenage workers falls?IF:

  • teenage workers are easily substituted for adult workers

  • the supply of adult workers is inelastic

  • teenagers account for a small proportion of total costs


What is believed about cross elasticities
What is believed about teenage workers falls?CROSS-ELASTICITIES:

  • labor and energy are substitutes (degree is small)

  • labor and materials are probably substitutes (degree is small)

  • skilled labor is likely to be a complement with capital

  • unskilled labor and capital are likely to be substitutes


Policy implications

Policy Implications teenage workers falls?

The Effects of Minimum Wage Laws


S teenage workers falls?0

DI


S teenage workers falls?0

minimum wage

DI


S teenage workers falls?0

minimum wage

DI



Difficulties of studying the effects of the minimum wage
Difficulties of studying the effects of the minimum wage: respect to the minimum wage?

  • holding other things constant

  • covered vs. uncovered sectors


Figure 4 3 federal minimum wage level and relative to wages in manufacturing 1938 2000
Figure 4.3 respect to the minimum wage?Federal Minimum Wage: Level, and Relative to Wages in Manufacturing, 1938–2000


Figure 4 4 minimum wage effects growing demand obscures job loss
Figure 4.4 respect to the minimum wage?Minimum Wage Effects: Growing Demand Obscures Job Loss


Figure 4 5 minimum wage effects incomplete coverage causes employment shifts
Figure 4.5 respect to the minimum wage?Minimum Wage Effects: Incomplete Coverage Causes Employment Shifts



There are two types of technological change to consider
There are two types of technological change to consider: for labor?

  • development of new products

  • automation (substituting capital for labor)


Development of new products
Development of New Products for labor?

  • The invention of new products that take the place of old may have large effects on labor

  • Workers producing the old products will see a decline in the demand for their labor services

  • However, new jobs should be created with the firm (or firms) producing the new products


Automation
Automation for labor?

  • This will likely have different effects on the markets for skilled and unskilled labor

  • Since skilled labor is probably a complement, new capital products will likely lead to an increase in the demand for skilled labor

  • Since unskilled labor is probably a substitute, new capital products will likely lead to a decrease in the demand for unskilled labor


In either case (new products or automation) the effects of technological change on total employment in the economy are likely to be positive.


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