Holt 7525-9 S15_IT

Since producers will attempt to equalize the ratio of MPP to factor price for all factors, the price of
a factor will depend on the factor’s productivity. If Factor B is twice as productive as Factor A,
Factor B will have a price twice as high as factor A.
Elasticity of Demand for Labor
The elasticity of demand for labor measures the responsiveness of employers to a change in the
wage rate. The elasticity of demand for labor is the percentage change in the quantity demanded
of labor divided by the percentage change in the wage rate. There are three determinants of the
elasticity of demand for labor:
1. The number of substitute factors. The more substitute factors for labor, the more elastic the
demand for labor. The fewer substitute factors for labor, the less elastic the demand for labor.
Example 9A: The donut makers at Darla’s Delectable Donuts ask for a 10% raise. If Darla can
readily replace these workers with equally skilled donut makers, she is unlikely to grant the raise.
With many substitute factors available, Darla’s demand for donut makers will be elastic.
Example 9B: The rocket scientists at Roger’s Rockets ask for a 10% raise. If Roger can not
readily replace these rocket scientists with equally skilled rocket scientists, he is likely to grant the
raise. With few substitute factors available, Roger’s demand for rocket scientists will be inelastic.
2. The price elasticity of demand for the product that the labor produces. The more elastic
the demand for the product, the more elastic the demand for the labor that produces the
product. The less elastic the demand for the product, the less elastic the demand for the labor
that produces the product.
Example 10A: Darla’s Delectable Donuts faces competition from numerous other donut shops.
The demand for Darla’s donuts is highly elastic. As a result, Darla’s demand for donut makers is
highly elastic.
Example 10B: Roger’s Rockets faces little competition in the rocket market. The demand for
Roger’s rockets is highly inelastic. As a result, Roger’s demand for rocket scientists is highly
inelastic.
3. The percentage that labor costs make up of total costs. The higher the percentage that
labor costs make up of total costs, the more elastic the demand for labor. The lower the
percentage that labor costs make up of total costs, the less elastic the demand for labor.
Example 11A: Labor costs make up 80% of total costs at Farah’s Fashionable Hairstyles. A 10%
raise for Farah’s stylists would mean a large increase in Farah’s total costs. As a result, Farah’s
demand for stylists is highly elastic.
Example 11B: Labor costs make up 15% of total costs at Roger’s Rockets. A 10% raise for
Roger’s rocket scientists would mean a small increase in Roger’s total costs. As a result, Roger’s
demand for rocket scientists is highly inelastic.
Labor Supply Curve for a Perfectly Competitive Employer
The labor supply curve shows the quantity of labor supplied at different wage rates. A perfectly
competitive labor employer is a small employer in a large labor market. A perfectly competitive
labor employer has no market power (no ability to affect the market wage rate). For a perfectly
competitive labor employer, the labor supply curve will be horizontal (perfectly elastic) at the
market wage rate. Wage and marginal factor cost are the same.
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24 - 5 Factor Markets