Chapter 4 Labor Demand Elasticities Ownwage Elasticity of

Chapter 4: Labor Demand Elasticities

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

Elasticity and Slope n n 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.

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

Elasticity Along a Linear Demand Curve

Elasticity Along a Linear Demand Curve

Elasticity and Slope Comparisons

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

Hicks-Marshall Laws of Derived Demand Own-wage elasticity of labor demand is relatively high when: n n 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.

First Hicks-Marshall Law n n 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: n n 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.

Second Hicks-Marshall Law n n 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.

Third Hicks-Marshall Law n n 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.

Fourth Hicks-Marshall Law n n 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: n n 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.

Hicks-Marshall Laws and Union Strategy n n n 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.

Hicks-Marshall Laws and Union Strategy n n 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.

Cross-wage (Cross-price) Elasticity of Demand n n 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.

Empirical Estimates of Cross-wage Elasticities n n 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.

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

Minimum Wage Effects Noncovered Sector

Minimum wage (or union) in a monopsony

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

Empirical Results n n n 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).

Technological Change n n 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.