Chapter 4. Labor Demand Elasticities.

1. 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

2. Elasticity of Labor Demand • OWN-WAGE ELASTICITY OF DEMAND. 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.

3. Elasticity of Labor Demand • For a given level of wages, a steeper labor demand curve is more inelastic

4. 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?

5. HICKS-MARSHALL LAWS OF DERIVED DEMAND Based on scale or substitution effects, why is labor demand more elastic when: • product demand is more elastic • other inputs can be easily substituted for labor • the supply of substitutes is more elastic • labor is a larger share of total cost

6. 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)

7. Estimates of Own Wage Elasticity of Labor Demand Summary of studies by Daniel Hammermesh (1993)

8. Application: Unions & Elasticity • Unions wish to raise wages while preserving employment. • How does elasticity of labor demand affect union “bargaining power”?

9. 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?

10. Application: Unions & Elasticity • TL: Average union rate 28.4 cents.mile; union-non-union ratio of 1.23 • LTL: average union rate 35.8 cents/mile; union-non-union ratio 1.34

11. 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.

12. Cross-Wage Elasticity 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)

13. 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).

14. 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.

15. 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.

16. 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?

17. Real value of minimum wage

18. 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?

19. Application: Minimum Wage Laws Monopsony & minimum wage MEL LS W2 W1 MRP L1

20. 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?