Elasticity of labour demand and labour supply

Overview

Elasticity of demand for labour measure, availability of machinery affect the elasticity of demand for labour and elasticity of supply of labour measure.

What you need to know

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Questions from this subtopic

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1. 1

   What does the elasticity of demand for labour measure, and how is it calculated?

   Model answer

   It measures how responsive the quantity of labour firms want is to a change in the wage rate. It is calculated as the percentage change in the quantity of labour demanded divided by the percentage change in the wage, where each percentage change is the change divided by the original value multiplied by 100. Because the two variables move in opposite directions the value is negative. A value between 0 and minus 1 is inelastic; beyond minus 1 it is elastic.

2. 2

   A wage rise of 10% in an industry reduces employment from 200 workers to 190. Calculate the elasticity of demand for labour and say what it shows.

   Model answer

   The change in employment is 190 minus 200, which is a fall of 10 workers. As a percentage that is -10 ÷ 200 × 100 = -5%. Elasticity of demand for labour = percentage change in the quantity of labour ÷ percentage change in the wage = -5 ÷ 10 = -0.50. The value lies between 0 and minus 1, so demand for labour is inelastic: employment falls proportionately less than the wage rises. The industry's total wage bill therefore increases.

3. 3

   Which four factors determine how elastic the demand for labour is?

   Model answer

   The price elasticity of demand for the final product: if buyers desert the product when its price rises, firms cut labour sharply. Labour's share of total cost: where wages are a large part of costs, a wage rise bites hard. The ease and cost of substituting capital equipment or other types of worker. And the time period: given longer, firms can redesign processes and install machinery, so demand for labour becomes more elastic.

4. 4

   Why is the demand for labour more elastic when demand for the final product is price elastic?

   Model answer

   A wage rise raises the firm's costs and it must pass some of that on in a higher product price. If demand for the product is price elastic, buyers cut their purchases sharply, output falls a long way and the firm needs far fewer workers. If product demand is inelastic, sales barely fall, the firm keeps producing much the same output and employment changes little. The responsiveness of labour demand therefore inherits the responsiveness of demand for the product.

5. 5

   Two firms both face a 10% wage rise. In one, wages are 70% of total costs; in the other, 10%. Whose demand for labour is more elastic?

   Model answer

   The firm where wages are 70% of costs. There a 10% wage rise raises total costs by about 7%, forcing a large price rise, a big loss of sales and heavy job cuts. In the other firm the same wage rise raises total costs by only about 1%, which can be absorbed with little change to price, output or employment. The greater labour's share of total cost, the more elastic the demand for labour.

6. 6

   How does the availability of machinery affect the elasticity of demand for labour?

   Model answer

   If a reliable machine can do the job at reasonable cost, a wage rise pushes the firm to replace workers with capital, so the quantity of labour demanded falls a lot and demand is elastic. Where no good substitute exists, as in much personal care, skilled craft work and roles needing complex judgement, the firm has to keep the workers whatever the wage, so labour demand is inelastic. The cost of installing and running the substitute matters as much as whether it exists.

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