Chapter 4. Labor Demand Elasticities.

Major points.• Measuring elasticity of labor demand.• Determinants of the elasticity of labor

demand• Consequences of inelastic or elastic labor

demand• Measuring cross elasticity of labor demand• Consequences of a positive or negative

cross elasticity of demand

Elasticity of Labor Demand• OWN-WAGE ELASTICITY OF DEMAND.

where Ei is the level of employment for type i labor and Wi is the wage rate for type i labor

use mid-point for calculating percent changes

• If > 1, labor demand is elastic. • < 1, labor demand is inelastic.

i

iii W

E

%

%

Elasticity of Labor Demand

• For a given level of wages, a steeper labor demand curve is more inelastic

LD1LD0

At any given wage rate, LD0 is more inelastic than LD1.

Elasticity of Labor DemandFor a linear labor demand curve, the "midpoint" divides the curve into an elastic and an inelastic portion.

•Calculate elasticity for wages between

•$10-12

•$6-8

•$2-4

•What happens to total labor income as the wage rises?

•What wage maximizes total labor income?

HICKS-MARSHALL LAWS OF DERIVED DEMAND

Based on scale or substitution effects, why is labor demand more elastic when:

1) product demand is more elastic

2) other inputs can be easily substituted for labor

3) the supply of substitutes is more elastic

4) labor is a larger share of total cost

Estimates of Own Wage Elasticity of Labor Demand

From text: British manufacturing firms•Scale Effect -0.53•Substitution Effect -0.45 (-0.15--0.75)•Overall -0.93 (-1.0---1.4)

Estimates of Own Wage Elasticity of Labor Demand

Summary of studies by Daniel Hammermesh (1993)

Application: Unions & Elasticity

• Unions wish to raise wages while preserving employment.

• How does elasticity of labor demand affect union “bargaining power”?

Application: Unions & Elasticity

• Truckload (TL) and Less than Truckload (LTL)– TL: hauling grain from one part of country to

another.– LTL: UPS, FEDEX

• Where is product demand more elastic?• Where is labor demand more elastic?• Where should unions have greater

bargaining power?

Application: Unions & Elasticity

• TL: Average union rate 28.4 cents.mile; union-non-union ratio of 1.23

• LTL: average union rate 35.8 cents/mile; union-non-union ratio 1.34

Application: Unions & Elasticity

• Unions will be most successful at raising wages in industries with inelastic labor demand.– Labor versus capital intensive– Monopolistic versus competitive

• Unions will pursue & promote policies that make labor demand more inelastic.– Trade restrictions– Minimum wage– Immigration

• Unions might first seek to organize workers in markets where labor demand is inelastic.

Cross-Wage Elasticity

j

iij W

E

%

%

If cross elasticity >0 i & j are gross substitutes (substitution effect > scale effect)

If cross elasticity <0 i & j are gross complements (substitution effect < scale effect)

Cross-Wage Elasticity

Determinants of cross-elasticity:• As type k labor's share of total cost increases, the scale

effect of an increase in Wk grows, making it more likely that Ej drops (i.e. more likely gross complements).

• As product demand becomes more elastic, the scale effect of an increase in Wk grows, making it more likely that Ej drops (i.e. more likely gross complements).

• As the substitutability between the two types of labor increases, the substitution effect of an increase in Wk on Ej grows (i.e. more likely gross substitutes).

Cross-Wage Elasticity

Some empirical evidence:• labor and energy are substitutes in production,

but the degree of substitutability is small.• labor and materials are probably substitutes in

production, with the degree of substitutability being small

• skilled labor is more likely to be complementary with capital than unskilled labor.

Application: Minimum Wage Laws

History of minimum wages.• Fair Labor Standards Act of 1938:

– minimum wage– requirements for overtime pay premium– restrictions on use of child labor

• Minimum wage provisions in 1938– $.25 per hour– covered 43 percent of all nonsupervisory wage and salary

workers – coverage limited primarily to large firms involved in interstate

commerce.– minimum wage is stated in nominal terms and is not indexed. – changes in the minimum wage currently require legislative

action.

Application: Minimum Wage Laws

• Historical values of minimum wage.

• Minimum wage variation across states.

• Who Earns the Minimum Wage?

• Is  Minimum Wage Employment Long Lasting?

Application: Minimum Wage Laws

• The debate over the desirability of a minimum wage hike turns on:– Elasticity of labor demand– Who earns the minimum wage (effect on

family poverty rates)– Would a minimum wage hike hurt training and

reduce future wage growth?– Monopsony power.

Application: Minimum Wage Laws

Monopsony & minimum wage

MRP

LS

MEL

W1

W2

L1

Application: Minimum Wage LawsMonopsony & minimum wage• With monopsony, what is

– Level of employment– Wage?

• With minimum wage between W1 & W2, what happens to employment?

• With minimum wage above W2, what happens to employment?

• How does elasticity of LD affect employment response?