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How Elastic is The Demand for Labor?

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  • Kim B. Clark
  • Richard B. Freeman

Abstract

This paper investigates the magnitude of the elasticity of demand for labor in time series data using more general and complete models of demand than have been previously employed. It argues that previous analyses have imposed two invalid constraints in calculations, which bias downward estimated elasticities. The first invalid constraint is the assumption that real capital prices have an equal opposite effect to real wages in the demand equation. We show on measurement error grounds that this constraint should not be imposed in econometric work even when long run homogeneity of prices correctly characterizes the market. The constraint is rejected in the data. The second invalid constraint is that all explanatory variables have the same lag distribution. We argue that this constraint is invalid when decisions are made under uncertainty and find that it is also rejected by the data. The principal positive empirical finding is that with the constraints relaxed, the elasticity, of demand with respect to real wages is much larger than the estimates in the literature, indicating much greater price responsiveness on the demand side of the labor market than has previously been thought.

Suggested Citation

  • Kim B. Clark & Richard B. Freeman, 1979. "How Elastic is The Demand for Labor?," NBER Working Papers 0309, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:0309
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    1. Binswanger, Hans P., 1973. "A Cost Function Approach To The Measurement Of Factor Demand Elasticities And Elasticities Of Substitution," Staff Papers 13478, University of Minnesota, Department of Applied Economics.
    2. Rosen, Sherwin & Nadiri, M Ishaq, 1974. "A Disequilibrium Model of Demand for Factors of Production," American Economic Review, American Economic Association, vol. 64(2), pages 264-270, May.
    3. Ernst R. Berndt & Bronwyn H. Hall & Robert E. Hall & Jerry A. Hausman, 1974. "Estimation and Inference in Nonlinear Structural Models," NBER Chapters,in: Annals of Economic and Social Measurement, Volume 3, number 4, pages 653-665 National Bureau of Economic Research, Inc.
    4. Marc Nerlove, 1967. "Distributed Lags and Unobserved Components in Economic Time Series," Cowles Foundation Discussion Papers 221, Cowles Foundation for Research in Economics, Yale University.
    5. Y. Mundlak, 1968. "Elasticities of Substitution and the Theory of Derived Demand," Review of Economic Studies, Oxford University Press, vol. 35(2), pages 225-236.
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    Cited by:

    1. Thomas Vendryes, 2011. "Migration constraints and development: Hukou and capital accumulation in China," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) hal-00783794, HAL.
    2. Matthew J. Slaughter, 1997. "International Trade and Labor-Demand Elasticities," NBER Working Papers 6262, National Bureau of Economic Research, Inc.
    3. Michael Kremer & Benjamin A. Olken, 2009. "A Biological Model of Unions," American Economic Journal: Applied Economics, American Economic Association, vol. 1(2), pages 150-175, April.
    4. Michael T. Shannon & Charles M. Beach, 1995. "Distributional Employment Effects of Ontario Minimum-Wage Proposals: A Microdata Approach," Canadian Public Policy, University of Toronto Press, vol. 21(3), pages 284-303, September.
    5. Richard B. Freeman, 1979. "The Effect of Demographic Factors on Age-Earnings Profiles," Journal of Human Resources, University of Wisconsin Press, vol. 14(3), pages 289-318.
    6. Daniel S. Hamermesh, 1983. "New Measures of Labor Cost: Implications for Demand Elasticities and Nominal Wage Growth," NBER Chapters,in: The Measurement of Labor Cost, pages 287-308 National Bureau of Economic Research, Inc.
    7. Mairesse, Jacques & Dormont, Brigitte, 1985. "Labor and investment demand at the firm level : A comparison of French, German and U.S. manufacturing, 1970-79," European Economic Review, Elsevier, vol. 28(1-2), pages 201-231.
    8. Jonathan Gruber & Alan B. Krueger, 1991. "The Incidence of Mandated Employer-Provided Insurance: Lessons from Workers' Compensation Insurance," NBER Chapters,in: Tax Policy and the Economy, Volume 5, pages 111-144 National Bureau of Economic Research, Inc.
    9. Jesus Felipe & John S.L. McCombie, 2013. "The Aggregate Production Function and the Measurement of Technical Change," Books, Edward Elgar Publishing, number 1975.
    10. Hijzen, Alexander & Swaim, Paul, 2010. "Offshoring, labour market institutions and the elasticity of labour demand," European Economic Review, Elsevier, vol. 54(8), pages 1016-1034, November.
    11. Rudy Fichtenbaum & John P. Blair, 1989. "Regional Differences in Labor Demand in The United States," The Review of Regional Studies, Southern Regional Science Association, vol. 19(1), pages 72-76, Winter.
    12. Hamermesh, Daniel S., 1987. "The demand for labor in the long run," Handbook of Labor Economics,in: O. Ashenfelter & R. Layard (ed.), Handbook of Labor Economics, edition 1, volume 1, chapter 8, pages 429-471 Elsevier.
    13. Giovanna Aguilar & Sílvio Rendon, 2010. "Employment And Deadweight Loss Effects Of Observed Nonwage Labor Costs," Economic Inquiry, Western Economic Association International, vol. 48(3), pages 793-809, July.
    14. Cousineau, Jean-Michel, 1991. "L’effet du salaire minimum sur le chômage des jeunes et des femmes au Québec : une réestimation et un réexamen de la question," L'Actualité Economique, Société Canadienne de Science Economique, vol. 67(2), pages 144-165, juin.
    15. Carlos Medina & Christian M. Posso & Jorge A.Tamayo & Emma Monsalve, 2012. "Dinámica de la Demanda Laboral en la Industria Manufacturera Colombiana 1993-2009: una Estimación Panel VAR," BORRADORES DE ECONOMIA 009372, BANCO DE LA REPÚBLICA.
    16. Brigitte Dormont, 1989. "Petite apologie des données de panel," Économie et Prévision, Programme National Persée, vol. 87(1), pages 19-32.
    17. Slaughter, Matthew J., 2001. "International trade and labor-demand elasticities," Journal of International Economics, Elsevier, vol. 54(1), pages 27-56, June.
    18. Guillermo Mondino & Silvia Montoya, 2000. "The Effects of Labor Market Regulations on Employment Decisions by Firms: Empirical Evidence for Argentina," IDB Publications (Working Papers) 3263, Inter-American Development Bank.
    19. Alexander Hijzen & Paul Swaim, 2007. "Does offshoring reduce industry employment?," National Institute Economic Review, National Institute of Economic and Social Research, vol. 201(1), pages 86-96, July.
    20. repec:eee:labchp:v:1:y:1986:i:c:p:429-471 is not listed on IDEAS

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