Elasticity of Labour Demand

Elasticity of Labour Demand

Labour is a derived demand realised by the demand for the product that the labour will be producing. The theory of ‘labour demand’ explains the behaviour of the firm with the key principle being to achieve the optimal amounts of labour employers will want to utilise at different wage levels.

We must make several assumptions when describing how the long run labour demand is derived. Firstly we must assume that firms are profit maximisers and therefore will attempt always to minimise any costs incurred. Further assumptions to simplify analysis of labour demand are that there are no costs of employment other than hourly wages and productivity of labour is independent of time worked. I.e. Labour is homogenous. The production process involves only two inputs, Labour (L) and
Capital (K):

The firmsÂ’ production functions in the short and long run:

qSR = f(K, L)

qLR = f(K, L)

In the long run, the firms’ capital stock is not fixed at any level; K is now changeable as opposed to the short-run where the firm is burdened with a stock of capital that might not be the optimal level under the current market conditions. In the indeterminate ‘long run period’, the firm will therefore be able to select optimal combinations of its variable stock. A firm will now have more than one tool to use in order to capitalize on profits. The only long run constraint of the firm would be given by technology.

To find the preferred choice of inputs we can examine different quantities of K and L given the ratio of the input prices with a level of output. These choices are depicted in a curve called an isoquant.
An isoquant demonstrates a set of points where output is identical but different combinations of labour and capital are possible.

Diagram Isoquant

Criteria:

· Isoquants are downward sloping
· Isoquants can not intersect
· A higher isoquant is associated with a higher level of output
· An isoquant must be convex to the origin (displaying diminishing returns to scale)

The slope of the isoquant is derived by moving between two points on the curve. Moving from A to B will maintain the level of output but change the ratio of inputs. In this case it will lower the capital stock from K1 to K2 but increase the level of employment from L1 to L2
.Output is decreased by the units of capital stock cut multiplied by the marginal product of capital, but i...

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...as I have summarised), a one percent rise in the wage leads to a 30 per cent drop in employment levels. Private strategies are also affected, as a unionÂ’s bargaining strategy will be influenced by the elasticity. The more inelastic the employers demand for labour, the stronger the negotiations will be to oppose a wage cut. Unions would be more uncompromising when offered a lower wage.

References:

Books

- Borjas, G. J. (2004), Labour Economics, 3rd Edition, McGraw-Hill

- Hamermesh, D., Rees, A. (1988), The Economics of Work and Pay, 4th
Edition, Harper & Row

- McConnel, C. R., Brue, S. L., (1989), Contemporary Labour Economics, 2nd
Edition, McGraw-Hill Book Company

Websites

- www.jstor.ac.uk

- http://labour.ceps.lu/

Journals

- Chiswick, C. U. (1985), “The Elasticity of Substitution Revsited: The effects of secular changes in labour force structure”, Journal of
Labour Economics, Vol 3 No. 4, pp 490-507

- Oi, W. (1962), “Labour as a quasi-fixed factor”, Journal of Political
Economy, Vol 70, pp 538-55

- Symons, J. and Layard, R. (1984), “Neoclassical demand for labour functions for six major economies”, Economic Journal, Vol 94, pp
788-99