Chapter 4: Labor Demand Elasticities

Transcription

1 Chapter 4: Labor Demand Elasticities Labor Economy Fall 2009 The focus of this chapter is on the degree to which employment responds to changes in wages. The responsiveness of labor demand to a change in wage rates is normally measured as an elasticity, which in the case of labor demand is the percentage change change in employment brought about by a 1 percent in wages. The Own-Wage Elasticity of Demand Own-wage elasticity of demand (negative): η ii = % E i % W i Whether the absolute value of the elasticity of demand for labor is greater than or less than η ii > 1: elastic 2. η ii < 1: inelastic 3. η ii = 1: unitary elastic Aggregate earning decline 1

2 The Hicks-Marshall laws of derived demand The laws assert that, other things equal, the own-wage elasticity of demand for a category of labor is high under the following conditions: 1. The price elasticity of demand of output is high. 2. Other factors can be easily substituted for labor. 3. The supply of other factors of production is highly elastic. 4. The cost of employing labor is a large share of the total cost of production. Two effects of how the wage rate affects the demand for labor: 1. The substitution effect: 2. The scale effect: 2

3 Demand for the final product The greater the elasticity of demand for the product, the greater the elasticity of demand for labor. 1. Implication: other things equal, the demand for labor at the firm level will be more elasticity than the demand for labor at the industry or market level. 2. Implication: wage elasticities will be higher in the long run than in the short run. 3

4 Substitutability of other factors The easier it is to substitute other factors of production, the higher the wage elasticity of labor demand will be. Limitations on substitution possibilities: 1. Union rules 2. Government legislation The supply of other factors The share of labor in total costs Estimates of Own-Wage Labor Demand Elasticities The estimates are based on studies that utilize wage, output, and employment data from firms or narrowly defined industries. These estimates are suggestive of what might be a typical response, but of course are not indicative of what would happen with any particular firm. Employer s labor demand responses to wage change can be broken down 1. Scale effect 4

5 2. Substitution effect Applying the Laws of Derived Demand: Inferential Analysis Unions value both wage and employment opportunities for their members. The key point is that for any given percentage increase in wages the more elasticity the demand curve, the greater percentage decline in employment. Implication 1. Union would win larger wage gains in markets with inelastic labor demand curves. 2. Union would strive to reduce the wage elasticity. 3. Union might organize workers in inelastic market. The Cross-Wage Elasticity of Demand The cross-wage elasticity of demand exams the elasticities of demand for inputs with respect to the price of other inputs. Cross-wage elasticity of demand: η jk = % E j % W k η kj = % E k % W j 5

6 1. η jk > 0 & η kj > 0: gross substitutes 2. η jk < 0 & η kj < 0: gross complements The relative sizes of the scale (< 0) and substitution (> 0) effects Can the Laws of Derived Demand be Applied to Cross-Elasticities? The relative strengths of substitution or the scale effect of the four conditions determines the sign of cross-elasticities. With cross-elasticities, the substitution effect and scale effect work in opposite directions. An example in mind: what might happen to the demand for adult workers (E A, W A ) if the wages of teenage workers (E T, W T ) were to fall? 1. The Scale Effect: W T production cost product demand and output level all employment, especially, both (E A, W A ) What conditions are for a strong scale effect? 6

7 2. The Substitution Effect: A technological condition affecting the size of the substitution effect is a direct carryover from the second Hicks-Marshall law: the substitution effect will be greater when the category of labor whose price has changed is easily substituted for other factors of production. 3. Estimates Relating to Cross-Elasticities Policy Application: Effects of Minimum Wage Laws A minimum wage rate, below which hourly wages could not be reduced. It is specified in nominal terms and not in terms relative to some other wage or price index. Employment Effects: Theoretical Analysis// Key: If the demand curve for low-wage workers is elastic: the percentage loss of employment among lower wage workers is greater than the percentage increase in their wage. An increase in the minimum wage makes aggregate earnings of low-wage workers smaller. Nominal versus Real Wages The employment effects of a uniformly applied minimum wage law is adverse in regions with lowest cost of living. 7

8 Holding other things constant Prediction of job loss associated with higher minimum wage are made holding other things constant. Minimum Wage Effects: Growing Demand Obscure Job Loss Effects of Uncovered Sectors The existence of uncovered sectors significantly affects how the overall employment of low-wage workers will response to increse in the minimum wage. Minimum Wage Effects: Incomplete Coverage Causes Employment Shifts Covered sector v.s. Uncovered sector Intersectional Shift in Product Demand Example: convenience stores v.s. supermarkets 8

9 Employment effects: Empirical estimates The demographic group for which the effects of minimum wages are expected to be the most visible are teenagers-a notoriously low-paid group! Does the Minimum Wage Fight Poverty? 9