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.
% Ei
ii 
% 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 gii > 1, labor demand is elastic.
•
< 1, labor demand is inelastic.
Elasticity of Labor Demand
• For a given wage, 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
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.
Predictions for Union Wages
• Substitution of capital for labor
– Reduced labor demand and less employment
– More capital intensive
• Effect on elasticity of labor demand?
• Effect on union bargaining power and wages?
• Effect on power of strike threat?
• More competitive product market
– Reduced Increased competition
– Effect on elasticity of labor demand
Dockworkers
• Containerisation radically altered cargo handling
• Capital substituted for labor
• Port of NY/NJ
• 1970: 30,000 longshorement
• 1986: 7,400.
Dockworker Earnings, Containerisation, and Shipping Deregulation
Author(s): Wayne K. Talley
Source: Journal of Transport Economics and Policy, Vol. 36, No. 3 (Sep.,
2002), pp. 447-467
Dockworkers
• 1984 deregulation of shipping increased competition across ports
• Allowed “door-to-door” rates in addition to “port-to-port”
• Made it possible for shippers to decide on best combination
of routes for “door to door”
• Ports began competing with others 100s of miles away
• East coast began competing with west coast
• Asia shipping to East Coast began dropping cargo off ship on
west coast and using rail across the states.
Dockworker Earnings, Containerisation, and Shipping Deregulation
Author(s): Wayne K. Talley
Source: Journal of Transport Economics and Policy, Vol. 36, No. 3 (Sep.,
2002), pp. 447-467
Cross-Wage Elasticity
%Ei
ij 
%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
• 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: Technological
Change
• Does technological advance make society
worse off?
– PPF as illustration of gains from technological
advance.
– Winners and losers
• Gross compliments or gross substitutes?
– Gains exceed loss, but can winners
compensate losers?
• Unemployment insurance, retraining, etc.
• These programs lead to inefficiencies as well.