Chapter 4.
Labor Demand Elasticities.
• 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.
%Ei
hii 
%Wi
|
|
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 hii > 1, labor demand is elastic.
•
< 1, labor demand is inelastic.
Elasticity of Labor Demand
• For a given level of wages, a steeper labor
demand curve is more inelastic
At any given wage rate,
LD0 is more inelastic than LD1.
LD0
LD1
Elasticity of Labor Demand
For 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; unionnon-union ratio of 1.23
• LTL: average union rate 35.8 cents/mile; unionnon-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
%Ei
hij 
%W j
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.
The minimum wage today
• $7.25 federal minimum
– Some states have higher than federal
minimum
– Various minimum wage exceptions apply
•
•
•
•
•
workers with disabilities
full-time students
youth under age 20 in first 90 days of empl
tipped employees
student-learners.
– Who Earns the Minimum Wage?
Real value of minimum wage
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.
– Short run versus long run?
Application: Minimum Wage Laws
Monopsony & minimum wage
MEL
LS
W2
W1
MRP
L1
Application: Minimum Wage Laws
Monopsony & 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?