Ch. 5: Demand for Labour finished

1
Lecture 5

• Ch. 5 Demand for Labour (finished)
• Deriving long run labour demand schedule
• Elasticity of demand
• Trade and the labour market
• Ch. 6 Demand for Labour
• Quasi-fixed costs

2
Profit Max. in Long Run (contd)
Slope - MPN / MPK
- MPN / MPK -w/r or MPN / MPK w/r

Capital (physical units)
A
Slope -w/r
K1
Q1
Cost1
N1
Labour (Number)
3
LR Labour Demand Curve (contd)

• In the long run, firm can vary both capital and
  labour
• As wage rate changes, what quantity of labour
  will the firm employ in order to maximize profits
• Labour demand falls as wage rises for two
  reasons
• Substitution effect
• Scale effect

4
LR Labour Demand Curve (contd)

• SUBSTITUTION EFFECT
• firm would substitute cheaper inputs for the more
  expensive labour
• e.g., Wage of cashiers increase, so more capital
  intensive method (e.g., self-service checkout) to
  process (the same number of) customers could be
  used.

5
Deriving Long Run Labour Demand
Wage increase from W1 to W2
Slope -w2/r1
B

Substitution Effect
KB
Capital (physical units)
A
Slope -w1/r1
KA
Q1
Cost1
Cost2
Cost3
NA
NB
Labour (Number)
6
LR Labour Demand Curve (contd)

• SCALE EFFECT
• Firm would reduce its scale of operations because
  of the cost increase associated with the increase
  in wage
• When wage rates paid to employees increase,
  prices of product likely to increase.
• Faced with higher prices, consumers buy less
• Since reduced demand, fewer employees needed
• e.g., Wage of cashiers increase ? price of
  products increase ? fewer customers ? fewer
  cashiers needed

7
Long Run Labour Demand (contd)
Wage increase from W1 to W2
Slope -w2/r1
B
Cost1
Scale Effect

KB
C
Capital (physical units)
KC
A
Slope -w1/r1
KA
Q1
Q2
Cost4
Cost2
Cost3
NA
NB
NC
Labour (Number)
8
LR Labour Demand Curve (contd)

• Question If wages increase, does capital
  decrease or increase?
• Answer It depends
• Substitution effect increases use of capital
• Scale effect decreases use of capital
• e.g., If cashiers wage rate increases, then
• More self-serve checkout units because substitute
  away from labour into capital
• Less self-serve checkout units because price
  increases mean fewer customers

9
Derived Labour Demand
Downward sloping because of Substitution effect
when labour is more expensive, use more capital
and less labour Scale effect when labour is more
expensive, costs increase, therefore less output
is demanded
Wage rate ()
W2

W1
NA
NC
Labour (Number)
10
Derived Labour Demand (contd)
Wage rate ()
W2

W1
D2
D1
Demand Curve if output can vary
Demand Curve if output is fixed
NA
NC
NB
Labour (Number)
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Elasticity of Labour Demand

• Measures the responsiveness of the quantity of
  labour demanded to changes in the wage rate
• Equals the change in the quantity of labour
  demanded divided by the change in the wage
  rate ?N / ?W
• Important to know since the predicted employment
  losses of a wage increase depend, in part, on
  this elasticity

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Elasticity of Labour Demand (contd)

• Elasticity changes along demand curve
• E ?N / ?W
• E1 (20-10)/10)
• (10-12)/12
• 1/ -0.1667 -6
• E2 (60-50)/50)
• (2-4)/4
• 0.2/ -0.5 -0.4

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Elasticity of Labour Demand (contd)
Larger employment decrease associated with wage
increase when demand for labour is ELASTIC
Wage rate ()
W2

W1
DELASTIC
DINELASTIC
N1
N3
N2
Labour (Number)
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Elasticity of labour demand (contd)

• Four basic determinants of the elasticity of
  demand for labour
• Availability of substitute inputs
• Can be machinery (capital) or other types of
  labour
• Degree of substitutability determined by
  technology and by government regulation

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Elasticity of labour demand (contd)

• Elasticity of supply of substitute inputs

Labour Market for Nurses (as substitutes for
doctors)
Supply
Wage rate
Demand2
Demand1
Number of workers
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Elasticity of labour demand (contd)

• Price elasticity of demand for output
• Determines the magnitude of the scale effect
• If price increase can be passed on to the
  consumer, then labour demand will be inelastic
• Inelastic product demand health services
• Elastic product demand food at a particular
  restaurant

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Elasticity of labour demand (contd)

• Ratio of Labour Cost to Total Cost
• Importance of being unimportant
• If labour is small part of total costs, employers
  wont try as hard to minimize labour costs.

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Elasticity of labour demand (contd)

• Example 1 Elasticity of demand for professors
• availability of substitute inputs
• elasticity of supply of substitute inputs
• elasticity of demand for output
• ratio of labour cost to total cost

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Elasticity of Labour Demand (contd)

• On the basis of a number of studies, elasticity
  of labour demand averages about -0.30
• Q. Using this estimated elasticity, what do you
  guess the employment loss due to the recent
  minimum wage increase in Ontario?
• Minimum wage went from 6.85 to 7.15. June
  employment in Ontario was about 6,400,000
• A Elasticity -0.3 ?N / ?W
• ?N -0.3 x 0.043 -0.0129
• ?N ?N / N ?N / 6,400,000 -0.0129
• ?N -82,560

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Impact of Trade on Labour Market

• Profit maximization in short run (in a
  competitive market)
• MRPN MPN x P W
• If P?, then W? (holding MPN constant)
• If P?, then MPN ? to hold MRPN and W constant
• Does MPN ? because Canadian labour becomes more
  productive?
• Does MPN ? because less labour employed?

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Impact of Trade on Labour Market

• Profit maximization in long run
• (MPCanadian N / MPForeign N) WC / WF
• Relative productivity is important when
  comparing Canadian and foreign wages
• International comparisons of compensation costs
  (W) in 1999 (pg. 160)
• Germany 173 Japan 135 US 106 Canada 100
  Korea 43 Mexico 14.

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Quasi-fixed costs

• Definition
• Labour costs incurred by the firm that vary
  directly with the number of workers hired but are
  independent of the number of hours each person
  works
• Examples
• hiring costs
• training costs
• dismissal costs
• nonwage benefits

23
Quasi-fixed costs (contd)

• Importance of quasi-fixed costs
• Helps explain observed phenomena like
• Overtime work
• Hiring and firing behaviour

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Non-wage benefits
See BGR, page 173 for source
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Non-wage benefits (contd)

• Why exist and growth?
• Income tax considerations some nonwage benefits
  are not taxed. Examples include
• contributions to registered pension plan
• Contributions to private health services plan
  (covering drugs, hospital stays, etc.)
• Employee discounts
• Tuition fees in courses related to business
• Subsidized meals
• Use of employers recreational facilities

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Non-wage benefits (contd)

• Why exist and growth? (contd)
• Economies of scale
• Beneficial to employers
• subsidized meals ? shorter lunch/dinner breaks
• recreational facilities ? healthier employees,
  more group cohesion
• tuition ? better educated employees
• deferred compensation ? reduce turnover, provide
  work incentives, and screening device.

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Present Value

• Present value is a method of translating a flow
  of future income or savings into its current
  (i.e., present) value.
• Logic behind time value of money.
• A received today is worth more than a
  received in the future
• A invested at 5 interest for 1 year 1.05
• FV PV(I r)t FV future value, PV present
  value, r interest rate t of yrs.

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Present Value (contd)

• What is the present value of a dollar received
  10 years from today (at 3 interest)
• FV PV(Ir)t
• PV FV/(1 r)t
• PV 1/(1.03)10
• PV 1/1.3439 0.74

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Present Value (contd)

• Example What is the present value of Cash for
  Life lottery?
• It pays 1,000 a week per life.
• To simplify our example 50,000/yr.
• Suppose you live 40 more years. Is value just 2
  million (i.e., 40 x 50,000)?
• PV 50,000/(10.03)150,000/(10.03)2
• .50,000/(10.03)40

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Profit maximization with quasi fixed costs

• Without fixed costs
• Wage Value of marginal product
• With fixed costs (2 periods) (r is interest
  rate)
• Hiring Training wage1 wage2 / (1r)
• Value of marginal product1
• value of marginal product2 / (1r)
• Therefore wage1 wage2 / (1r) lt
• Value of marginal product1
• value of marginal product2 / (1r)

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Labour Demand with Quasi Fixed Costs
BUFFER
VMP1
W1
Wage Rate ()
VMP1
VMP2
VMP1 (HT)
N2
N1
N1
Number of workers
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Quasi-fixed costs (contd)

• Labour hoarding
• The employment practice of firms retaining
  workers during a cyclical downturn even if the
  marginal revenue product is below the wage level
  in the current period
• Explains why productivity growth is cyclical
• Explains why unskilled labour is more affected by
  cyclical downturns than skilled labour

33
Quasi-fixed costs (contd)

• Employers hiring decisions in face of increased
  demand for firms output
• Greater incentive to use overtime of existing
  staff (instead of hiring more)
• Greater incentive to have employees put forth a
  greater work effort (instead of hiring more)

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Worksharing

• Quasi-fixed costs may explain employers
  reluctance to engage in worksharing
• Definition of worksharing Each person works
  fewer hours but more people work
• As a policy, it receives more attention during
  periods of high unemployment
• Government legislation may increase reluctance of
  employers to workshare
• e.g., ceilings on payroll taxes

35
Worksharing (contd)

• It is clear that there are too few jobs.
  However, the
• challenge lies not only in the number of jobs but
• also in their distribution. Redistribution of
  work
• could help Canadians balance work and family
  life,
• provide greater access to employment for those in
• need, and enhance opportunities for people to
• pursue education and skills upgrading. It could
  also
• offer an option for people who would, under
  certain
• circumstances, prefer to work fewer hours.
• Lloyd Axworthy, Minister of Human Resources
  Development, 1994

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Worksharing (contd)

• Preferences of Canadian workers
• At this job, given the choice, at your current
  wage rate, would you prefer to work
• (1) fewer hours for less pay?
• (2) more hours for more pay?
• (3) the same hours for the same pay?
• Appetite for worksharing seems low
• 27.1 said more hours
• 6.4 said fewer hours
• 66.6 said same hours
• (Source, Drolet and Morissette, 1997)

37
Quasi-fixed costs (contd)

• Lump of labour fallacy
• Fallacy says that there are a fixed number of
  hours of work to be shared by population.
• However, if costs of new hours worked gt costs of
  hours worked now shared, then
• Average costs of production could rise
• Quantity demanded falls
• Employment demand falls