Transcript Chapter 4: Demand for Labor in Short Run

Chapter 4: Demand for
Labor in Short Run
• Demand for labor: level of
employment (L) desired by business
firms.
• Topics:
– Factors that determine a firm’s optimal
level of employment;
– How this optimal level responds to
changes in wages, cost of capital, firm’s
sales, and technology changes.
• Short run (SR): time period when
capital (K) is fixed.
• Long Run: all inputs variable.
Pattern of Employment
Over Time
• See Figure 4.1.
• Level of employment reflects
demand for labor.
• Three important features:
• 1) Huge  # jobs:
– 1950: 60 million;
– 2001: 156 million.
• 2)  composition of jobs:
–  Agriculture;
– big growth service and government
(now 80% of jobs).
• 3) cyclical variation in # jobs.
– 10 recessions between 1950 and 2002.
Marginal Productivity
Theory of Demand
• Simplifying assumptions:
• 1) firm’s goal is to maximize
$ profits
• 2) Two factors of production (K
and L).
• 3) Both input and output
markets are perfectly
competitive, or PC (wages and
prices treated as fixed).
• 4) Wages are only cost of labor
and labor is homogeneous.
Firm’s Hiring Decision
in the Short Run (SR)
• Now K fixed; only L variable.
• Rule: Hire another worker as
long as the worker adds at least
$1 to profits.
• Or: hire another worker as long
as the cost of that worker (his
wage) is less than or equal to
the value of that worker’s extra
output.
New Terms
• Production Function: shows how
inputs can be combined to produce
output, given a specific state of
technology.
• Q = F(K, L)
– Q = output
– K = capital
– L = labor
• SR: Firm can only  Q by  L.
• TP = total product = Q
• TPL = TP at each amount of L (with
K fixed).
More Terms
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Marginal product of labor:
MPL = Q/L.
Average product of labor:
APL = Q/L.
Total revenue = TR = P * Q.
Marginal revenue = MR = TR/Q;
where MR = P. See each unit of Q
sold at same market price.
• Marginal revenue product of labor:
MRPL = MPL * MR.
• Marginal cost of labor: MCL = wage.
Firm’s Equilibrium
Level of Employment
• Rule: keep hiring one more
worker until worker’s marginal
benefit (value of extra output)
equals that worker’s marginal
cost (wage).
• General Rule:
• W = MR * MPL = MRPL
• With PC assumption: P = MR.
• So: W = P * MPL or W/P = MPL
• See Table 4.1 and Figure 4.2.
To Note About
Figure 4.2
• MPL = slope of tangent line at
specific amount of L.
• APL = slope of line from origin to
the point on the TP associated with
specific amount of L.
• Relate shape of TPL to MPL: as long
as TPL getting steeper, MPL is going
up. (Relate point A to point L1)
• Note that MPL hits APL from above,
at max point of APL
• Law of Diminishing Returns: With
K fixed: at some point, MPL declines
( L will  Q at decreasing rate).
Back to Table 4.1
• Impose the optimal hiring rule:
• 5th worker:
– MRPL = 60 but W = only 40  yes hire
5th worker.
• 6th worker:
– MRPL = 40 and W = 40  yes hire 6th
worker.
• 7th worker:
– MRPL = 8 but W = 40  NO hire the
7th worker.
• So it is optimal to hire 6 workers.
Firm’s SR Demand
Curve for Labor
• Shows relationship between wage
rate and firm’s desired employment
level holding all other relevant
factors (including other inputs) fixed
(like K).
• Firm’s SR demand curve for labor IS
the downward portion of the MRPL
curve.
• Ignore upward sloped portion
because at any price or wage, firm
will hire as much labor as possible.
Demand for Labor
Curve
• Two points to Stress:
• 1) A change in the wage causes
movement along a given DL
curve.
• 2) A change in a ceteris paribus
factor (e.g., capital price or
utilization, product demand)
will cause a shift in the entire
DL curve.
Effect of  Product
Demand on DL
• Key: product demand is D curve
in output market; remember S
and D curves for output, with
intersection yielding P*.
• With  product demand, this is
shift to right of D curve, causing
P* to go up.
• Back to firm:
– MRPL = MR * MPL where
P=MR.
– So P   MRPL (shift to right)
Imperfect Competition
in Product Market
• Key: with perfect competition, price
always equals MR (and both same
for any Q). Like saying that firm
faces horizontal D curve and can sell
at it wants to at P*.
• If product market is not competitive:
firm faces downward sloping
product demand curve, so if  Q, P.
• So, MR  P and more steep.
• So this DL curve:
– 1) lies to left of original DL.
– 2) it is steeper.
Example
• Key: With imperfect competition:
firm faces downward sloped product
demand curve, so to Q, must  P.
• Q = 10 when P = $10
• So TR = P*Q = 10 * 10 = $100
• Now Q = 12 and P = $9, so
• TR = 12 * 9 = $108.
• MR = TR/Q = 8/2 = 4.
• MR = 4 but P = 9.
Derivation of
Market DL Curve
• Start by defining market (e.g.,
by geographical area or by
industry).
• Two factors:
– 1) Total market DL curve is sum
of each individual firm’s DL
curve.
– 2) If all firms experience a W so
 their DL, this makes market S
curve for output shift right,
pushing down market P; so MRPL
for each firm must be redrawn.
Effect of  Wage
• 1) If wage change only affects
one firm, causing movement
along given DL curve.
• 2) If wage change affects every
firm in the industry, then it will
also affect market price and so
each firm will have entirely new
DL curve (because this curve is
the MRPL curve, which equals
P * MPL under p.c.).
Criticisms of Standard
DL Theory
• Starting Point: The theory does
yield fairly good predictions of
firm’s optimal level of
employment and how optimal
level will  in response to
economic events.
• Five Criticisms of DL Theory
– 1. Limits to human cognition:
requires too much knowledge and
rejected by firm case studies.
– 2. Non-maximizing behavior
(ownership vs management)
Continue with Criticisms
– 3) Fixed K/L proportions
– 4) Increasing returns to L
(perhaps MPL varies across
business cycle).
– 5) Interdependence between
wage and worker productivity.
– Overall: real world data support
basic features of standard model.
Exercise
• Textbook pg. 216, #1: Use the
marginal productivity theory of
LD to predict the impact on the
firm’s employment level of the
following events (explain;
graph).
–
–
–
–
A)  in wage rate.
B)  demand for firm’s product.
C) lower tariff on imported goods
D) conversion of firm from
perfectly competitive firm to noncompetitive firm.
Elasticity of DL
• Elasticity of DL measures
responsiveness of labor demand
to changes in the wage rate.
• ED = %L / %W  0
• Note:
%L = L/L
%W = W/W
• ED = (L/L) / (W/W)
•
= (L/W) * W/L
• ED = (1/ slope of DL) * W/L
Five Cases of ED
• 1) ED = 0: W causes no L
– Perfectly inelastic
– vertical demand curve
• 2) ED  1: %W  %L
– DL not very responsive to  wage.
– Inelastic
– Steep DL curve
• 3) ED = 1: %W = %L
– Unit Elastic
More Cases of ED
• 4) ED  1
–
–
–
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DL very responsive to wage es
%L  %W
Elastic
Relatively flat DL curve
• 5) ED = - 
• Firm willing to hire any # workers at
prevailing market wage but none at
any higher wage.
– Perfectly elastic
– Horizontal (flat) DL curve
• See Figure 4.6.
Elasticity Along
a Single DL Curve
• One relatively flat DL curve is
relatively more elastic than a steeper
curve, but for all straight line DL
curves, there is an elastic portion and
an inelastic portion.
• Recall 2nd part of ED is W/L.
• As move down DL curve to right,
W while L, so W/L  and so ED is
 too.
– Starts elastic and becomes inelastic.
• See Figure 4.7.
Relationship Between
ED and Total
Expenditures on Labor
• Total expenditures on labor is called
the firm’s wage bill.
• Wage bill = W * L.
• Question: When have W, how will
wage bill ?
• Answer: Compare %W to %L
(W always  L; issue is by how
much?)
• 1) Inelastic: %W  %L
– So W leads to  wage bill.
• 2) Elastic:
%W  %L
– So  W leads to  wage bill.
Example
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Example 1:
Wage  from $8 to $7
% Wage change = -12.5%
Employment  from 20 to 30
% Employment change = 50%
ED = 50 /-12.5 = - 4
– Very elastic or responsive
• Example 2
• Wage  50% and L  12.5%
• ED = 12.5 / 50 = 0.25
– Inelastic (not very responsive)
What Determines ED?
• Ease of substitutability:
– 1) Between K and L
– 2) Between this good and other
goods.
• Evidence from data:
– 1) data show DL curve slopes
down.
– 2) DL curve relatively inelastic.
– 3) ED is greater for unskilled and
blue-collar workers than skilled
and white-collar workers (due to
greater subst K/L for former).
Relationship Between
DL and Product Demand
• * DL is a derived demand.
• 1) DL over business cycle
–  hrs or  # workers?
• 2) DL and consumer expenditure
patterns (relates to es in
preferences and es in income)
• 3) Impact of imports on domestic
employment (key: substitutes versus
complement goods).
– NAFTA: North American Free Trade
Agreement: winners versus losers.
Squeeze on Middle
Class Jobs
• Trend in 1980s and 1990s: net
job loss in mid-level jobs.
– Banking: middle management
– Manufacturing: high wage union
jobs.
Wage Subsidy Programs
• Designed to encourage employers to
hire the hard-core (longterm)
unemployed.
• The subsidy will  cost to firm of
hiring this type of worker (makes
them relatively less expensive).
• Standard program design:
–
–
–
–
1. Categorical eligibility
2. Only covers new hires
3. Covers workers with w wt
4. Subsidy is some % of difference
between actual w and wt;
– Subsidy = r(wt – wa)
– 5. Subsidy usually temporary.
Effects of Subsidy
Program
• Good effects:
– 1)  employment of target group;
– 2) gives largest subsidy to hardest to
employ (since their wages are lowest);
– 3) as hard-to-employ take jobs and
gain experience, their wages rise so
subsidy cost falls.
• Bad effects:
– 1) employer might replace some
current workers with new (covered)
workers;
– 2) employer might keep subsidized
worker for the temporary period then
layoff and hire NEW covered worker.
– 3) subsidy eligibility can be a stigma.
Union Wage
Concessions
• Issue: Why unions might accept
wage cuts? To preserve
employment!
• Labor demand theory suggests:
union wage concessions most likely
to occur in industries that face a
relatively elastic DL and are
experiencing falling output so shifts
leftward in DL.
• Data support this theoretical
implication.
Exercise: ED
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Start: W = $10 and L = 80.
Now: W = $20 and L = 60.
1. Calculate ED.
2. Calculate original and new
total wage bill.
• 3. Relate the change in total
wage bill to the calculated ED