Chapter 4: Labor Demand Elasticities

Own-wage Elasticity of Labor Demand

Labor demand is said to be:

Elasticity and Slope
 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:
 an increase from 1 to 2 is a 100% increase,
 an increase from 2 to 3 is a 50% increase,
 an increase from 3 to 4 is a 33% increase,
 an increase from 4 to 5 is a 25% increase,
 an increase from 10 to 11 is a 10% increase, and
 an increase from 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:
 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:
 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
 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:
 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
 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
 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
 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:
 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
 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
 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

 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
 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
 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:
 unemployment and economic inefficiency if
the labor market is perfectly competitive and
there is complete coverage,
 economic inefficiency if the labor market is
perfectly competitive and there is a non-
covered sector, and
 an ambiguous effect on the level of
employment if firms possess some degree of
monopsony power.
Empirical Results
 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
 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.