4. Elasticities of Labor Demand 4A. Own-Wage Elasticity E151A: C.Cameron n Own-wage elasticity of demand for labor n What determines how much labor h = the % change in employment due to demand falls when wage increases? a 1% change in the wage rate (h is eta). n What happens when price of capital (or n E.g. h = -0.5 other inputs) increases? Þ employment ¯ 0.5% when w•1.0% n What happens when minimum wage n h = %DE / %Dw where %D is % change increases? n h= -1 if unit elastic demand -1 < h< 0 if inelastic demand -h< -1 if elastic demand

4A. Hicks Marshall Laws of 4A. Airline deregulation & pilots Derived Demand n Pre-1978 low wage elasticity of demand n Other things equal h is high when: since applying Hicks-Marshall laws 1. Price elasticity of demand for output 1. Low price elasticity of demand due to good is high (scale) lack of competition amongst airlines 2. Other factors of production can be 2. Difficult to substitute other inputs easily substituted for labor (substitution) 3. Not as relevant 3. Supply of other factors of production 4. Airline pilots small part of total costs is highly elastic (substitution) n Post-1978 de-regulation: 4. Cost of employing labor is a large competition changes 1. share of total production costs (scale)

4A. Examples 4A. Empirical Estimates n Unions like wage inelastic demand. n Vary greatly across studies. n Training programs most successful if E.g. E&S at plant level labor demand highly elastic (otherwise n scale effect h = -0.5 wage will fall greatly). (measure as short-run effect so no sub.) n Employment tax credits or wage n substitution effect h = -0.5 subsidies have more effect the more (measure when no change in output) elastic is labor demand. n total effect h = -1.0 (measure as long-run effect).

1 4B. Cross-wage Elasticity 4B. Cross-wage elasticity n When price of capital increases n 1. Scale effect: output ¯ Þ L ¯ hjk = the cross-wage elasticity of input j with respect to the price of input K 2. Substitution effect: Capital relatively more expensive Þ n h = %DE / %Dw jk j k a. Substitutes in prodn: L • n Main three inputs we consider are b. Complements in prodn: L ¯ skilled labor, unskilled labor, capital n Overall: price capital • Þ labor D ? n Not clear whether these inputs are Labor demand • then gross substitutes gross substitutes with hjk > 0 Labor demand ¯ then gross complements gross complements with hjk < 0

4C. Minimum Wage 4C. Minimum Wage (cont.) n From chapter 3 n Winners: workers who keep their jobs wskilled/wunskilled = MPskilled/MPunskilled n n Losers: workers who lose jobs Problem if MPunskilled is low. firms n One solution is education to • MP unskilled consumers via higher prices n Another is increase w by law unskilled n On balance lose as introduces Pareto n Fair Labor Standards Act (1938) inefficiency because leads to MRPL brought in federal minimum wage being different in different labor designed to be a livable wage markets. n California introduced min wage in 1916.

LABOR MARKET WITHOUT MINIMUM WAGE LABOR MARKET WITH MINIMUM WAGE

Covered Uncovered Market Covered Uncovered w w w w w

wmin wc wu wc wu DC D D u D DC wu u E E E E E* E W exceeds w so people lose jobs in covered sector For simplicity total supply wage inelastic and equals E* min e and move to uncovered sector bidding down wage. Now MRP differes across the sector. Pareto inefficient.

2 4C. Min Wage Pareto Inefficient n MRPL differs in two sectors Þ Pareto inefficient as there is a possible win-win situation (increase output by switching marginal worker from one sector to other) n The minimum wage blocks this transfer n Minimum wage bad as Pareto inefficient

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