1 / 52

Labor Demand

Labor Demand. Chapter 4. Labor Demand Questions. Which workers should a firm hire? How many workers should a firm hire? How much capital? How will firms respond to employment subsidies? How should firms respond to policy changes such as minimum wages, affirmative action, etc?.

obert
Download Presentation

Labor Demand

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. Labor Demand Chapter 4

  2. Labor Demand Questions • Which workers should a firm hire? • How many workers should a firm hire? How much capital? • How will firms respond to employment subsidies? • How should firms respond to policy changes such as minimum wages, affirmative action, etc?

  3. Production Function • Describes the technology used to produce goods and services • q = f(E,K) where • q = output • E = number of employee hours hired = number of workers x average hours per worker • K = capital – land, machines, other physical inputs • Assume homogenous workers (ignore education, etc) • Output is a function of the number of employee hours hired by the firm and the quantity of capital employed

  4. Production Function, cont. • Recall: q = f(E,K) • Marginal Product: • MPE = • MPK = • MP = slope of total product curve • Interpretation:

  5. Production Function Example

  6. Example, cont.

  7. Production Function Characteristics • TP increases rapidly, then at a decreasing rate • When TP increases at an increasing rate, MP • When TP increases at a decreasing rate, MP • When TP decreases, MP • Law of Diminishing Marginal Returns: • MP, AP relationship • AP increases when MP AP • AP decreases when MP AP • MP = AP at

  8. Short Run Employment Decision • Firms goal: where • w = cost of hiring an additional worker • r = price of capital • p = output price • Short run: • E*: Choose E* such that • VMPE=P·MPE  taken as given for PC firms

  9. SR Employment Decision Example • Let w = $32, P=$3 • If E = 2, VMP = $33, but w = $32, so 3rd worker • If E = 3, VMP = $24, but w = $32, so 4th worker • w = $32 falls between VMP(E=1)=30 and VMP(E=2)=36, but • If law of diminishing MP did not hold, E* would have no bounds, so diminishing MP ensures firm can- not influence market

  10. SR Employment Decision, cont. • Recall: • APE increases when MPE APE • APE decreases when MPE APE • MPE = APE at • VAPE = P∙APE is a “blown-up” version of APE, so VMPE = VAPE at • E* only valid if • If VMP(E*) = w > VAP(E*),

  11. Individual Firm Demand Curve • Demand curve: Allow price (wage) to vary and determine how many employees the firm demands • If w = $15, E* = • If w = $21, E* = • If w = $24, E* = • SR demand curve for labor is:

  12. Individual Firm Demand Curve, cont. • VMP curve drawn for a particular price, so when output price changes, VMP (labor demand) curve shifts • Positive relationship between P and the short-run demand for labor • Capital costs (r) constant, and when P↑, revenue ↑ • Firms only increase E* when revenue from new worker exceeds cost of worker (VMP > w)

  13. Labor Market Demand Curve • Recall: Market labor supply curve derived by • Market Demand Curve • Roughly • Caveat:

  14. Labor Market Demand Curve, cont. • Because of the caveat, the true labor market demand curve is ______ than the horizontal sum of individual demand curves

  15. Profit Maximization Approach • Recall: Profit maximizing firms choose q* such that MR = MC, where • For a fixed K (short run condition), • For a PC firm, P = MR, so operating at MR = MC implies:

  16. Objections to MP Theory • Note: • MP Theory: Choose E* such that w = VMPE • E* implies q* based on the production function • Employers do not really calculate VMPE and find where w = VMPE • Adding employees to the production process while holding K constant will not increase marginal productivity

  17. Elasticity of SR Labor Demand • How responsive is labor demand to changes in wages? • __________ (by definition): When wages increase, firms demand ______ workers • Interpretation: • Elastic (_____ responsive) when |δSR| 1 • Inelastic (_____ responsive) when |δSR| 1

  18. Long Run Employment Decision • Long run: • The firm can choose E* and K* • Isoquants: • Note: “iso” = equal, “quant” derived from quantity, so isoquant = “equal quantity”

  19. Characteristics of Isoquants • Do not intersect • Downward-sloping • Higher isoquants represent _______ levels of output • Convex to the origin • When E is large, a _____ ∆K could replace many workers and maintain the same q • When E is small, a _____ ∆K would be required to maintain the same q

  20. Characteristics of Isoquants, cont. • Slope: Move from point X to Y • Gain: • Loss: • To remain on the same isoquant, MPE∙∆E + MPK∙∆K = 0 • Slope = Marginal Rate of Technical Substitution (MRTS) • Interpretation: • Convexity implies diminishing MRTS

  21. Isocosts (Constraint) • Isocosts: • Isocosts further away from the origin imply _____ costs • Cost = wE + rK 

  22. Profit Max/Cost Min • Profit max  Cost min • Choose q* and produce at the lowest cost (isocost closest to origin) combination of K, E • Isocost-Isoquant tangency:

  23. Profit Max/Cost Min, cont. • To profit max, firms choose q* such that MR=MC, then choose K* and E* to minimize costs • Recall: MR = MC implied w = P∙MPE; analogously, it also implies r = P∙MPK • Therefore, profit max implies cost min

  24. Profit Max/Cost Min, cont. • So far, profit maximization implies cost minimization • Does cost minimization imply profit maximization? • Profit maximization Cost minimization, but • Cost minimization Profit maximization

  25. Long Run Demand Curve for Labor • Recall: Demand curve is derived by allowing price (wage) to vary and determine how many employees the firm demands • Suppose initially, q*=q0 with C=C0 and w=w0 • Cost effect of w↓ • If w↓, firm may buy more labor and incur C=C0, • If C↑ to C1, holding constant r, the entire budget line

  26. Long Run Demand Curve for Labor • Cost effect of w↓, cont. • With new cost (C1), new intercept = • Production effect of w↓ • When w↓, MC of production likely ________ (additional cost of producing one more unit ) • With _MC, MR _ MC at q0, so firm responds by _q • When w↓, E*_, K*_

  27. Scale and Substitution Effects • So far, we’ve seen that when wages decrease, production costs (MC) __crease, so firms have an incentive to __crease production and hire _____ workers (E* ) • Substitution Effect • Capital is now a relatively ______________ input, so firms SUBSTITUTE away from ________ and toward a more _______-intensive production process (K* and E* ) • Scale Effect (eliminates the change in relative prices) • When firms produce more output (because of decreased MC of production), they may hire _____ employees and _____ capital simply because the SCALE of production changes (K* and E* )

  28. Decomposing the Scale and Substitution Effects • To isolate the scale effect, draw a hypothetical isocost with same slope as original isocost and tangent to new isoquant • Scale Effect: __ to __ • Substitution Effect: __ to __ • As drawn, ___________ effect dominates, and K* • Note: Scale and substitution effects both suggest E*_, but the dominant effect determines how K* changes

  29. Long Run Demand Curve for Labor • Recall: Both scale and substitution effects suggest E*_ when w↓ • Scale effect: When q↑, firm demands more K and more E • Substitution effect: Firms demand more of the relatively less expensive input when w↓ • Therefore, the LR demand curve for labor is _________ sloping (E*_ when w↓)

  30. Elasticity of Labor Demand • δLR _ 0 because of the ______ relationship between w and E • δLR vs δSR: δLR _ δSR because firms can be more responsive to wage changes with fewer constraints (K not fixed in the long run) • Therfore, the LR demand curve for labor is ______ than the SR demand curve curve for labor

  31. Elasticity of Labor Demand • Short-run elasticity of labor demand: • -0.5 < δSR < -0.4 • Long-run elasticity of labor demand: • δLR ≈ -1 • 1/3 due to the substitution effect, 2/3 due to the scale effect

  32. Elasticity of Substitution • Perfect Substitutes • Here, 2K = 1E • Recall: Convexity of a “normal” isoquant implied • Here, inputs can be substituted at a ___________ rate • _________ substitution effect • One of the two extremes will be chosen (K = 100 OR E = 50, depending upon w and r)

  33. Elasticity of Substitution, cont. • Perfect Complements • If E = 5, K = 5, can produce just as much output as E = 5 and K = 25 • To increase output, must add • Always use ____________ for q0, regardless of w and r • _____ substitution effect (___ substitutability) between K and E

  34. Elasticity of Substitution, cont. • Elasticity of Substitution= • Measure of • When labor becomes relatively more expensive (w/r)↑, relatively ______ capital will be used (K/E) • Large elasticity of substitution means firms are _________ responsive to changes in relative input prices • More curved isoquants have _______ elasticities of substitution

  35. Policy Application: Affirmative Action • Affirmative action encourages firms to alter the race, ethnicity, or gender of workforce by hiring relatively more of the workers typically under-represented in past hiring • Assume: • Two types of inputs – black and white workers • Black and white workers may have different education levels, skills, etc. • wB = black wage, wW = white wage

  36. Policy Application, cont. • Case 1 • Note: Intercepts suggest wW _ wB • Point _ would be profit-maximizing (cost-minimizing) for a “color blind”, non-discriminating firm • A discriminating firm might choose point _ to have fewer black employees • A fine-tuned AA program could

  37. Policy Application, cont. • Case 2 • Note: Again, intercepts suggest wW > wB • Firm may be non-discriminating and still hire relatively more whites (point _), perhaps because of productivity differences, etc. • An AA program may force the firm to hire relatively more blacks (point _), which is no longer profit-maximizing • Therefore, AA programs may improve profitability if the firm is ________________, but will reduce profits if firms are _____ __________________

  38. Marshallian Rules of Derived Demand • Derived Demand: • What happens in the market for the good itself directly influences demand for labor (for instance, when P changes, VMPE (DE) shifts) • Marshallian rules describe factors which are likely to generate an elastic demand for labor

  39. Marshallian Rules of Derived Demand • Rule 1: Greater elasticity of substitution between labor and capital (less curved isoquants) • Rule 2: Greater elasticity of demand for output • When wages ↑, the MC of production ↑, so supply ↓ and output P↑

  40. Marshallian Rules of Derived Demand • Rule 3: Greater labor’s share of total costs of production • When labor is a large share of production costs, a wage change has a substantial impact on MC, on market supply (of output), and ultimately, on P

  41. Marshallian Rules of Derived Demand • Rule 4: Greater supply elasticity of other inputs to production • When w↑, the firm will want to • If the price of that input increases dramatically when more is demanded, the incentive to replace labor with other inputs is ___________ • If the supply of the other input is ________ (relatively _____ supply curve), the increase in demand will result in only a moderate price increase, so firms will be more likely to make substantial changes in the relative share of inputs in the production process

  42. Factor Demand with many inputs • So far, q =f(E,K) • Can add to the production function different types of workers, machines, etc. • q = f(x1,x2,…,xi,…xm) where • xi = quantity of input i • xi* determined by: wi=P∙MPi where • wi = cost per unit of input i (wage, rental rate, etc) • Results in the 2-input case hold in this more general set-up • Empirically, labor demand for unskilled workers is more elastic than the demand for skilled workers  Labor market much more unstable for unskilled workers

  43. Cross-Price Elasticity of Demand • How does the demand for input i (xi) respond to a change in the price of input j (wj)? • Cross-price elasticity of input demand • If inputs are substitutes (ηX-P _ 0), demand curve for input i shifts _____ in response to an increase in the price of good j)  ____________ effect dominates • If inputs are complements (ηX-P _ 0), demand curve for input i shifts _____ in response to an increase in the price of good j)  ___________ effect dominates

  44. Empirical Evidence • Skilled and unskilled labor • Empirically, skilled and unskilled labor are _________ (ηX-P _ 0) • Unskilled labor and capital • Empirically, unskilled labor and capital are ________ (ηX-P _ 0) • Cross-price elasticity of input demand ≈ 0.5 • Skilled labor and capital • Empirically, skilled labor and capital are __________ (ηX-P _ 0) • Cross-price elasticity of input demand ≈ -0.5

  45. Labor Market Equilibrium • Intersection of supply, demand defines (E*,w*) • If w > w*, QS _ QD   competition drives w_ to w* • If w < w*, QS _ QD   competition for workers drives w_ to w*

  46. Application: Minimum Wages • Fair Labor Standards Act (FLSA) • Established in 1938 • Created a minimum wage, established overtime laws, child labor laws, etc. • Minimum wage: price ______ on wages (min w _ w*) • Higher wage has two effects • Unemployed =

  47. Application: Minimum Wages, cont. • Recall: • With minimum wage, • Depends upon minimum wage, elasticities of S, D • UR higher when S, D more ________ (______ curves)  suggests firms and/or workers are responsive to wage changes

  48. Application: Minimum Wages, cont. • Empirical Evidence • Approximately 40% of workers who qualify for minimum wage are not paid it • Firms that are caught can delay paying a portion of payroll for two years (like an interest-free loan) and typically do not pay fines • Not all workers work in sectors covered by the minimum wage law (~10% in 1990)

  49. Application: Minimum Wage, cont. • Workers in covered sector displaced by the minimum wage may move to the uncovered sector. • The equilibrium wage in the uncovered sector would __crease. • Note that the wage in the covered sector would also __crease due to ________ workers supplying their services to that market (not shown).

  50. Application: Minimum Wage, cont. • Workers in uncovered sector may leave their current jobs to try to find new work in the covered sector to take advantage of minimum wage. • The equilibrium wage in the uncovered sector would __crease. • Note that the wage in the covered sector would also __crease due to an _________ in the number of workers supplying their services to that market (not shown).

More Related