Chapter 3 Labor Demand

Solution Assignment 3 Hick and Slutsky Old and new version Measurement at same utility (How you measure utility? or What is Thai’s utility function?) or same budget (you can measure it easily) Old and new version The new version measures at current situation but you can not go back to measure at the past.

We will talk about Profit maximization Two steps decision Short Run and Long run In the short-run With CE, price is exogenous variable Cannot change plant/equipment scale Fixed capital Consider MP

Why firm hire labor? Demand (for good and product) from consumer Firm acts as middleman  derived demand Labor is different from other resource Work situation (environment) Social status and Opportunity Need Respectful, Honor, Dignity

Production Function production function which is Example Cobb-Douglas Marginal Product Law of diminishing returns, marginal product

Optimal Point Value of Marginal Product Value of Average Product Optimal at condition At competitive market, it is equivalent to

Criticism on short run theory Homogenous assumption about workers Realistic How to calculate marginal product? How to identify production function?

Number of Workers Output AP MP TP

Output P2 VAP P1 VMP L is not optimal L is optimal Number of Workers

Wage Industry’s Demand P1 P2 Sum of Demand Number of Workers

Long Run Production In long run, all input variable can be changed Isoquant and Isoprofit Concept Shape of Isoquant depends on ability to substitution between two inputs

Example

Cost Minimization Given q* find the lowest C “Least cost combination” Capital Cost Minimization Given q* find the lowest C “Least cost combination” C1 C2 C* K* q* E* Number of Workers

Output Maximization If q3 = q* then C3 = C* Or If C3 = C* then q3 = q* Capital Output Maximization Given C* find the highest q If q3 = q* then C3 = C* Or If C3 = C* then q3 = q* C* K* q3 q1 q2 E* Number of Workers

Capital C1 C2 Expansion Path C3 K* q1 q2 q3 E* Number of Workers

Formal Derivation

note

Decreasing in Wage Rate Capital F E q2 q1 w1 w2 Number of Workers

Scale Effect and Substitution Effect Capital Scale Effect and Substitution Effect W1* This is WRONG!! G F E q2 w1 q1 w2 x1 x2 Number of Workers x3

Scale Effect and Substitution Effect Capital Scale Effect and Substitution Effect W1* C0/r G C1/r F E q2 w1 q1 w2 x1 x2 Number of Workers x3

About labor demand Always be downward sloping Decreasing in wage rate Scale effect  Increase Production  increase employment Substitution Effect  labor intensive  increase employment Factors will be reallocated More elastic of long run labor demand than short run labor demand

Determination factors of elasticity of demand Elasticity of substitution Elasticity of demand for product increasing price  lower demand  decreasing labor (if labor intensive production) Elasticity of supply for other inputs Depend on substitutable between inputs

Marshall’s Rule of Derived Demand labor demand is more elastic the greater the elasticity of substitution labor demand is more elastic the greater the elasticity of demand for the output labor demand is more elastic the greater labor’s share in total cost the demand for labor is more elastic the greater supply elasticity of other factors of production

Minimum Wage Form of Policy Discussion A national, government – legislated minimum wage A national minimum wage (outcome of collective bargaining agreement) An industry level minimum wage (industry collective bargaining) Discussion Should the minimum wage be reduced or increased? Is the minimum wage effective in reducing earning inequality and poverty? Why does a minimum wage exist?

Other Issues Elasticity of labor demand Elasticity of Substitution Instrumental variable technique