Labor Demand (Lectures 6 and 7)

Textbook reading Borjas, Chapter 3 Ehrenberg & Smith, Chapters 3 and 4. Cahuc & Zylberberg, Chapter 4.

Additional readings Acemoglu, Autor & Lyle: “Women, War and Wages: The Effect of Female Labor Supply on the Wage Structure at Midcentury” (JPE 2004) Card & Krueger: “A Re-analysis of the Effect of the New Jersey Minimum Wage with Representative Payroll Data” (AER 2000)

Motivation: Why study labor demand? The study of labor demand will help us understand the effects (on employment and wages) of: Minimum wage laws Employment subsidies Firing costs Safety requirements Etc. “how one feels about many labor market regulatory programs is a function of one’s beliefs about labor demand curves!” (Ehrenberg & Smith)

The basic model The production function Profit maximization The marginal product of labor How many workers to hire?

The short-run labor demand curve For a firm How the firm’s employment changes as w changes (for constant K). For an industry Not as simple as horizontally adding up all firms’ LD curves!

The short-run elasticity of LD The % change in employment for a 1% change in wage. What affects ESR? The cost of labor (w). The determinants of the demand for the final good (p). The firm’s technology (f). The structure of the market for goods.

Labor demand in the long run In the long run, K is not fixed. The firm chooses both K and L. Two decisions: The proportion of K to L (“substitution”), and The amount of output (“scale”). Isoquants, isocosts, and cost minimization

Isoquants and isocosts Isoquant: combinations of L and K that produce the same q. They describe the production function. The “substitutability” of K and L. Isocost: Combinations of K and L with the same cost to the firm. Cost minimization: For a given q, choose the lowest cost (lowest possible isocost).

The long-run demand curve What happens to the firm’s long-run LD when the wage changes? Substitution and scale effects

Labor demand elasticity Short and long run estimates. The long-run demand curve is more elastic than the short-run demand curve for labor. Many empirical estimates. See Acemoglu, Autor & Lyle (2004).

The elasticity of substitution A firm’s substitution effect depends on the curvature of the isoquant. Perfect substitutes and perfect complements.

Marshall’s rules of derived demand How LD varies with the unit costs of the factors. LD is more elastic: the greater the elasticity of substitution. the greater the elasticity of demand for the output. the greater labor’s share in total costs. the greater the supply elasticity of other factors of production.

Extensions Many inputs Adjustment costs Workers versus hours

1) Many inputs The model can be extended to many different types of E and K. The cross-elasticity of labor demand The capital-skill complementarity hypothesis

2) Adjustment costs In the basic model, firms adjust their LD instantaneously when things change. In practice, adjusting E may be costly to do quickly. Variable vs. fixed costs. Employment protection legislation “dynamics”

3) Workers versus hours In the basic model, no hours choice. In practice, firms can adjust labor by changing the n. of workers, or the hours per worker. A firm can use different combinations of N and h to produce the same output. Fixed costs of hiring. The overtime premium.

Estimating labor demand elasticity Acemoglu, Autor & Lyle (2004)

Application: Minimum wages Card & Krueger (1994, 2000).