Labor Demand Elasticities
Own-Wage Elasticity
• Review of the concept of elasticity in product
markets
• Own-wage Elasticity = percentage change in labor
demanded/percentage change in wage
ηii = %ΔLi/%ΔWi
• The own-wage elasticity is negative and often
elasticities are referred to as the absolute value of
the above expression.
• |ηii| > 1 Elastic %ΔLi > %ΔWi
• |ηii| = 1 Unit Elastic %ΔLi = %ΔWi
• |ηii| < 1 Inelastic %ΔLi < %Δwi
• Graphical illustration of elasticity
– Straight-line demand curve and changing elasticity
– Boxes
– Relative elasticities
Figure 4.2
Different
Elasticities
along a
Demand
Curve
Figure 4.1
Relative Demand Elasticities
Hicks-Marshall Laws of Derived
Demand
• The own-wage elasticity is related to:
– Price elasticity of demand for the product
• Length of time for adjustment
– Substitutability of inputs
• Technology
• Institutional
– Elasticity of supply of other factors
– Labor’s share of total cost
Estimates of Labor Demand
• Short-run vs. long-run elasticities
– Short-run → Scale effect
– Long-run → Substitution effect + scale effect
• Elasticities
– Scale effect – hold production technology or
(K/L ratio) constant
– Substitution effect – holds output constant
– Overall demand E\elasticity
Using ηii
• If the supply curve of labor is more inelastic than the
demand curve of labor
• , in the long-run labor will bear the majority of payroll
taxes.
• Collective Bargaining
– Unions will win larger settlements in industries with inelastic
demand
• Pilots versus attendants
• Full-truck vs. partial truck industry
– Unions will try to lower the own-wage elasticity
• Prevent substitution of other inputs:
– immigrant labor
– Outsourcing
– Higher minimum wages
– Unions will place higher priorities on unionizing industries with
inelastic demands
Cross-wage Elasticities
• Cross-wage elasticity is the percentage change in
demand for labor when the price of another input
(usually wages in a different occupation) changes;
ηjk = %ΔLj/%ΔWk
• ηjk> 0 gross substitutes
• ηjk< 0 complements
• Caveat: gross substitutes versus complements
depends upon the relative size of the substitution
and scale effects.
Determining Cross-wage
Elasticities
• Let us use the example of foreign labor versus
domestic labor, LF and LUS and WF and WUS.
• We know that if the WF↓ we will get two effects:
– Scale effect: WF↓ →MCQ↓ → LF↑ and LUS↑
– Substitution effect: WF↓ →(WUS/WF) ↑→LF↑ and LUS↓
• Now, if
– scale < subst, then LF and LUS are gross substitutes and
ηii > 0
– scale > subst, then LF and LUS are gross complements
and ηii <0
• So, cross-wage elasticities are determined by the
relative size of the scale effects.
– Scale effect increases if:
• price elasticity of the product increases, and
• The greater capital share of total costs.
– Call centers vs. hospitals
– Substitution effect increases if:
• The substitutability of inputs increase, and
– Skill is easily taught
• The greater elasticity of supply of other substitute inputs
Results of Empirical Studies of Cross-wage
Elasticities
• Labor and energy and Labor and materials are substitutes
but the degree of substitutability is small
• Skilled and unskilled workers are substitutes
• The relationships between capital and skilled and unskilled
workers is not clear, but:
– It appears that skilled workers are much more likely to be
complements with capital, and
– If skilled and unskilled workers are substitutes the degree of
substitutability of capital for skilled workers is less than for
unskilled workers
• Given that the price of high-tech capital has been falling,
the above indicates that:
– Skilled labor is more likely to be a gross complement of capital, so
as C↓ → demand for skilled labor↑
– Unskilled labor is likely to have a higher own-wage elasticity of
demand, so as C↓ → demand for unskilled labor will ↓
Policy Implications
• Foreign outsourcing:
– in the short-run and for easy to teach jobs that
can be performed by unskilled workers (read
partly as lacking in familiarity with US
culture), LF↑ and LUS↓
– In the longer-run, as WF↑, as is occurring in
India, the tendency to outsource will subside.
• Federal minimum wage:
– Fair Labor Standards Act of 1938
– Minimum wage is in nominal terms
– Prior to 1980, it was about 45% of the wage in
manufacturing, but since wages in
manufacturing have gone up (remember EROP
and productivity gains) it is averaging below
40%.
Figure 4.3
Federal Minimum Wage: Level, and
Relative to Wages in Manufacturing,
1938–2000
Uncovering the Effects of the Minimum Wage
• Economic theory predicts that the minimum wage will
likely create unemployment among the unskilled. The
challenges to testing this theory are
– Nominal versus real wages
• Inflation
• Regional differences
– Ceteris Paribus???
• demand shifts
• supply shifts
– Covered vs. uncovered sectors
•
•
•
•
Increases in coverage
Non-compliance
Increased employment and lower wages in non-covered
Intersectoral shifts in demand
– State minimum wage laws
Figure 4.4
Minimum Wage Effects:
Growing Demand Obscures Job
Loss
Figure 4.5
Minimum Wage Effects:
Incomplete Coverage Causes
Employment Shifts
On the One Hand and on the Other Hand
•
•
•
•
•
•
Overall, results from minimum wage studies appear to be
inconclusive
New studies seen to indicate that the demand for teenage workers
in the fast food industry are between .2 and .6.
Interestingly, this is below, not above, the overall unit elasticity of
the demand for labor.
This may indicate the presence of monopsony power in the market
for teenage labor.
Now, if the demand for teenage elasticity is inelastic, as the
minimum wage increases the total amount paid to teenagers
should increase. Evidence from the 1980’s suggest this but newer
evidence from the 1990’s shows no reduction in poverty among
teenagers.
The minimum wage appears to only affect about 20% of the
families in poverty, so it effectiveness in lowering poverty appears
to be limited.
Technological Change and Labor Demand Elasticity
• Technological Change
– Product demand changes
• New products → shifts in labor demand
• Elasticity of product demand → change is elasticity of demand
– Production process changes towards capital
• New technologies → lower the effective price of capital
• Lower capital prices → scale and substitution effects
• The size of these effects determines if capital and labor are gross
substitutes or gross complements
• Evidence suggests that skilled labor is more likely to be a gross
complement and unskilled labor is more likely to be a gross substitute
for capital
• Technological change may affect the mix of skilled versus unskilled
but it likely has no effect on overall employment in the long-run. It
does, however, lead to economic growth and most likely to increases
in economic welfare.