Long run effects of a change in wages

• Substitution EffectSubstitution Effect: Change in labor demand caused by a change in relative input prices, holding output fixed– Always toward input that became relatively

less expensive• Scale Effect: Scale Effect: Change in labor demand

caused by a change in output, holding relative input prices fixed– Always in the same direction as change in

output

Complements and substitutesSuppose price of capital falls. What will happen to

labor demand?

Substitution effect? Away from NAway from N

Scale effect? Toward NToward N

Total effect?Depends on whether gross substitutes or gross

complements

Complements and substitutes

• Two inputs x and y are gross substitutesgross substitutes if as the price of x rises, the quantity of y demanded rises– PX Substitution effect toward y – Scale effect away from y

Substitution effect dominatesSubstitution effect dominates

Complements and substitutes

• Two inputs x and y are gross complements gross complements if as the price of x rises, the quantity of y demanded falls– PX Substitution effect toward y – Scale effect away from y

Scale effect dominatesScale effect dominates

If gross complements, scale effect If gross complements, scale effect dominatesdominates

Suppose price of capital falls. What will happen to labor demand?

Substitution effect?

Away from NAway from NScale effect?

Toward NToward NTotal effect toward NTotal effect toward N

If gross substitutes, substitution If gross substitutes, substitution effect dominateseffect dominates

Suppose price of capital falls. What will happen to labor demand?

Substitution effect?

Away from NAway from NScale effect?

Toward NToward NTotal effect away from N

High wage

Low wage

H0

l0

Cost minimizing combination of H, l MPH P*MPH wH

MPl P*MPl wl

wH wl

P*MPH P*MPl

= =

=

Long-Run Demand for Labor and relative unit labor costs

Cost minimizing combination of H, l wH wl

P*MPH P*MPl

Approximate by relative unit labor costs: wH wl

P*(Q/N)H P*(Q/N)l

=

=

Judith Banister. “Manufacturing earnings and compensation in China.” Monthly Labor Review August 2005

Source: Bureau of Labor Statistics

Source: Bureau of Labor Statistics

Source: Bureau of Labor Statistics

Source: Bureau of Labor Statistics

Values >100 imply that costs have risen Values >100 imply that costs have risen faster in the U.S.faster in the U.S.

Golub S.S.; Hsieh C-T.“Classical Ricardian Theory of Comparative Advantage Revisited.” Review of International Economics May 2000

API / APUS

WI / WUS

Golub S.S.; Hsieh C-T.“Classical Ricardian Theory of Comparative Advantage Revisited.” Review of International Economics May 2000

Various corrections for currency value

Peter F. Orazem (1998) “Empirical Isoquants and Observable Optima: Cobb and Douglas at Seventy” Review of Agricultural Economics 20: 489-501.

No relationship between w and ULCNo relationship between w and ULC

Peter F. Orazem (1998) “Empirical Isoquants and Observable Optima: Cobb and Douglas at Seventy” Review of Agricultural Economics 20: 489-501.

As ULC increases, require rising tariff As ULC increases, require rising tariff protection to keep producingprotection to keep producing

Toyota vs GMProduction Time per Vehicle GM: 34.3 hours, 2.5% improvement since 2003 Toyota: 27.9 hours, 5.5% improvement since 2003 Source: 2005 Harbour Report

 Average Labor Cost per U.S. Hourly WorkerGM: $73.73 Toyota: $48 Source: GM & Toyota

 Profitability per VehicleGM: Loses $2,331 per vehicleToyota: Makes $1,488 per vehicle Source: 2005 Harbour Report

How important is outsourcing for job loss in the United States?

Brown , Sharon P., and Lewis B. Siegel. “Mass Layoff Data Indicate Outsourcing and Offshoring Work.” Monthly Labor Review 128 (August 2005): 3-10.

Action Mass Layoff Events Separations

Total excluding seasonal 3,222 641,519 (0.4% of LF)

with movement of work 366 73, 217 (11% of Total)

movement within country 259 (est) 57,020 (8.9% of Total)

movement out of country 107 (est) 16,197 (2.5% of Total)

52% of outsourcing is to China and Mexico

Bednarzik, Robert W. “Restructuring information technology: is offshoring a concern?” Monthly Labor Review 128 (August 2005): 11-21.

Outsourcing represents about 1% of all job losses

(U.S. destroys 30 million jobs per year)

U.S. has a $51 billion trade surplus in services

• From 1979-1999, 69% of nonmanufacturing workers who lost jobs from outsourcing found jobs within one year.

• 55% of these employed at lower pay• 25% had pay cuts of 30% or more

Circuit City lays off all sales associates paid 51 cents or more per hour above an "established pay range" - essentially firing 3,400 of its top performers in one fell swoop. Over the next eight months Circuit City's share price drops by almost 70%.