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Revisiting Marshall's Third Law: Why Does Labor's Share Interact with the Elasticity of Substitution to Decrease the Elasticity of Labor Demand?

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  • Saul D. Hoffman

Abstract

The third Marshall--Hicks--Allen rule of elasticity of derived demand purports to show that labor demand is less elastic when labor is a smaller share of total costs. As Hicks, Allen, and then Bronfenbrenner showed, this rule is not quite correct, and actually is complicated by an unexpected negative relationship involving labor's share of total costs and the elasticity of substitution. The standard intuitive explanation for the exception to the rule presented by Stigler and referenced in many textbooks describes a situation rather different than the one described in the rule. The author presents an example that illustrates the peculiar negative impact of labor's share operating via the elasticity of substitution and then explains why the unexpected relationship between labor's share of total cost, the elasticity of substitution, and the elasticity of labor demand holds.

Suggested Citation

  • Saul D. Hoffman, 2009. "Revisiting Marshall's Third Law: Why Does Labor's Share Interact with the Elasticity of Substitution to Decrease the Elasticity of Labor Demand?," The Journal of Economic Education, Taylor & Francis Journals, vol. 40(4), pages 437-445, October.
  • Handle: RePEc:taf:jeduce:v:40:y:2009:i:4:p:437-445
    DOI: 10.1080/00220480903238032
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    JEL classification:

    • J01 - Labor and Demographic Economics - - General - - - Labor Economics: General
    • J20 - Labor and Demographic Economics - - Demand and Supply of Labor - - - General

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