Chapter 4. Labor Demand Elasticities.

Major points.• 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

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 > 1, labor demand is elastic. • < 1, labor demand is inelastic.

i

iii W

E

%

%

Elasticity of Labor Demand

• For a given wage, a steeper labor demand curve is more inelastic

LD1LD0

At any given wage rate, LD0 is more inelastic than LD1.

Elasticity of Labor DemandFor 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?

HICKS-MARSHALL LAWS OF DERIVED DEMAND

Based on scale or substitution effects, why is labor demand more elastic when:

1) product demand is more elastic

2) other inputs can be easily substituted for labor

3) the supply of substitutes is more elastic

4) labor is a larger share of total cost

Estimates of Own Wage Elasticity of Labor Demand

Summary of studies by Daniel Hammermesh (1993)

Application: Unions & Elasticity

• Unions wish to raise wages while preserving employment.

• How does elasticity of labor demand affect union “bargaining power”?

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?

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

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.

Predictions for Union Wages

• Substitution of capital for labor– Reduced labor demand and less employment– More capital intensive

• Effect on elasticity of labor demand?• Effect on union bargaining power and wages?• Effect on power of strike threat?

• More competitive product market– Reduced Increased competition– Effect on elasticity of labor demand

Dockworkers

Dockworker Earnings, Containerisation, and Shipping DeregulationAuthor(s): Wayne K. TalleySource: Journal of Transport Economics and Policy, Vol. 36, No. 3 (Sep., 2002), pp. 447-467

• Containerisation radically altered cargo handling • Capital substituted for labor• Port of NY/NJ

• 1970: 30,000 longshorement• 1986: 7,400.

Dockworkers

Dockworker Earnings, Containerisation, and Shipping DeregulationAuthor(s): Wayne K. TalleySource: Journal of Transport Economics and Policy, Vol. 36, No. 3 (Sep., 2002), pp. 447-467

• 1984 deregulation of shipping increased competition across ports • Allowed “door-to-door” rates in addition to “port-to-port”

•Made it possible for shippers to decide on best combination of routes for “door to door”

• Ports began competing with others 100s of miles away• East coast began competing with west coast

•Asia shipping to East Coast began dropping cargo off ship on west coast and using rail across the states.

Cross-Wage Elasticity

j

iij W

E

%

%

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)

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).

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.

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.

Application: Technological Change

• Does technological advance make society worse off?– PPF as illustration of gains from technological

advance.– Winners and losers

• Gross compliments or gross substitutes?

– Gains exceed loss, but can winners compensate losers?

• Unemployment insurance, retraining, etc.• These programs lead to inefficiencies as well.