Elasticity of labour Demand

Topics: Supply and demand, Employment, Elasticity Pages: 10 (1693 words) Published: December 3, 2014
Elasticity of Labour Demand

A firm always incurs a change in labour or capital. It is important for a firm to know the effects on the wage or capital increase since it would help the firm make accurate decisions. A change in wage would make an impact on the firms employment. When there is a wage cut, it reduces the price of labour relative to that of capital, and now labour is cheaper. However, when the wage increase the price of labour increases and the firm would substitute away from labour toward capital. When the wage is either increasing or decreasing, there are two effects that we have to take into consideration: the scale effect and the substitution effect. In figure 1, we can see the two effects. The scale effect is when there is above from point P to Q. This process indicates what happens to the inputs as the firm expands production in the case where wages are being cut. In the scale effect, we are only looking at the changes of both capital and labour. However, the substitution effect is the move from point Q to point R; where the firm takes advantage of the labour being cheaper. Since in this case the wage is cheaper, then the firm adopts a more labour-intensive input mix. Substituting away from capital and toward labour. It is important to notice that firm would use less amount of capital or more depending on what effect dominates. If substitution effect dominated the scale effect the firm would use less capital. If on the other hand the scale effect dominated the substitution effect the firm would use more capital.

The elasticity of demand tells us what is the percentage change in the quantity demanded of either capital or labour with respect of a change in the wage or in the cost per unit of capital. The elasticity of labour demand could tell us what might happen to the workers if the minimum wage, for example, were to be raised; and how this would affect the labour market. In November 4, 2014 the Venezuelan president Nicolas Maduro says he was going to increase the minimum wage by 15% starting in December. It would be interesting to by how much this percentage change in wage would change the percentage of employment. Since the elasticity of labour demand is such a useful tool in understanding the changes in the labour market.  First  is  important  to  look  at  the  three  important  labour  demand  elasticity’s:   The wage elasticity of labour demand, the cross-elasticity of labour demand and

finally the elasticity of substitution. After looking at these important labour demand elasticities,  it’s  important  to  see  how  elastic  the  demand  of  labour  is. The wage elasticity of demand for labour measures the change in percentage in the quantity of labour demanded by the percentage change in the wage. We can denote this elasticity by:

Since the demand curve is downward sloping the elasticity is negative. When n>-1, we say that is elastic since a 1% change in wage will decrease employment by more than 1 percent; or rapidly. When n

Bibliography: Hamermesh,  D.  Do  labor  costs  affect  companies’  demand  for  labor?.  IZA  World  of  
Labor 2014: 3 doi: 10.15185/izawol.3
"Borjas Labor Economics studied : BUS 101 : Acadia : Class Note." Insert Name of
Site in Italics. N.p., n.d. Web. 6 Nov. 2014
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