Labor Demand Elasticities

1. Labor Demand Elasticities

2. The Concept of Elasticity

3. Examples

4. Example: Own-Wage Elasticity of Demand Subscript refers to demand for 1st commodity with regard to price of the 2nd. In this case both are labor. • Question: According to neoclassical theory, is this positive, negative, or either? Why?

5. Thinking about elasticity

6. Some Questions • Why do we use percentages instead of just the change? • What is the difference between elasticity and slope?

7. Some Conventions and Terminology • Because elasticities usually are either positive or negative but not both, we often just refer to their absolute values. • Elastic: • Inelastic: • Unitary: • We often think of this in terms of how the numerator changes in response to a change in the denominator

8. The Five Categories of Demand Elasticity Perfectly inelastic Perfectly elastic Elastic ∞ Inelastic Unit elastic

9. Relative Demand Elasticities Which is more elastic? More elastic Less elastic

10. Aggregate Earnings • Question: When w increases, what happens to W if η is: • Elastic • Inelastic • Unitary

11. Elasticity Changes Along The Curve

12. Figure 4.2 Different Elasticities along a Demand Curve Calculate the elasticity at a point on the curve.

13. Hicks-Marshall Laws of Derived demand

14. Hicks-Marshall Laws of Derived Demand John Hicks Alfred Marshall

15. The Hicks-Marshall Conditions(Derived Demand) • Price-elasticity of demand for the product is high • Non-labor factors can be easily substituted • Supply of other (typically non-labor) factors is highly elastic • Labor costs are a large share of total costs

16. Recall Substitution & Scale Effects • Substitution • Changes relative cost of labor • Causes substitution w/ other factors of production • Scale • Changes product price • Causes changes in the scale of operations

17. Demand for Final Product • The greater the price elasticity of demand for the product • The greater the change in quantity produced for a given change in price • Therefore the greater the change in the demand for labor • Firm level demand is more elastic than industry because demand for firm’s products are more elastic than industries

18. Substitutability of Other Factors • The easier it is to substitute other factors, the greater the elasticity of demand for labor • Seems pretty obvious

19. Supply of Other Factors • If supply of other factors is limited • Cost to substitute other factors is higher • Therefore elasticity of demand for labor would be lower • In general, the greater the supply of substitute factors, the greater the elasticity of demand for labor

20. Share of Labor in Total Costs • Scale effect depends on the size of changes in the product’s price • The greater labor’s share in total costs, the greater the effect of a change in the wage on the total price • Therefore, the greater the scale effect • Therefore, the greater the change in the demand for labor

21. Cross-Wage Elasticity of Demand for Labor

22. Cross-Wage Elasticity of Demand for Labor • Consider two different kinds of labor: j and k or

23. Do the Hicks-Marshall Laws Apply to Cross-Wage Elasticities? • Cannot apply them directly, because • Substitution and scale effects work in opposite directions • So let’s consider them separately

24. Scale Effects • Because a wage is a cost, a change (increase/decrease) in the wage of one kind of labor, j, should • change overall production costs in the same direction (increase/decrease), which should … • lead to price changes in the same direction (increase/decrease), which should … • stimulate • a change in the opposite direction (decrease/increase) of demand for the product and • a change in output in the opposite direction (decrease/increase)

25. So the scale effect on labor k … • Depends on the share of total costs devoted to the factor whose price changes • So, although it may seem odd, • if the wages of, say, manufacturing labor decreases (call this wj), • the demand for, say, administrative labor will increase (the demand curve shifts to the right) • by an amount depending on the share of total costs going to manufacturing labor

26. And as in the case of own-wage elasticity, the scale effect • depends on the price elasticity of demand for the product • the greater • the greater • This implies the likelihood of being gross compliments depends on the elasticity of demand for the product

27. Substitution Effects • If the two kinds of labor are complements, a change (increase/decrease) in the price of one will change (increase/decrease) the demand for the other in the same direction • If they are substitutes, the total effect will depend on which is greater, the scale or substitution effect

28. If they are substitutes … The greater the substitutability, the greater the substitution effect • A given change in wj • Leads to a greater change in Ek • If wj increases, the demand curve for k shifts to the left • If wjdecreases, the demand curve for k shifts to the right

29. Also if they are substitutes … The greater the own-wage elasticity of labor supply (for k), the greater the substitution effect • Because substitution causes a change in demand for k in the same direction as the change in wj • e.g., if wjfalls, demand for k will fall (the curve shifts to the left) • Which causes wkto changein the same direction as the change in wj, thereby counteracting the original substitution effect • But high own-wage elasticity of labor supply of k implies this will have less impact because the change in quantity of k demanded results in less change in wk