2 - Procura de Trabalho

Labor Demand
Economia do Trabalho
2023/2024
Economia do Trabalho () Labor Demand 2023/2024 1 / 37

These slides are based on Cahuc, Carcillo, and Zylberberg (2014) and
Boeri and van Ours (2021).
Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 2 / 37

In this chapter we will
See how …rms choose their factors of production
Analyze substitution between capital and labor
Study the e¤ects of the adjustment costs of labor

Introduction
The theory of labor demand is deeply related to that of production

factors
The demand for labor must therefore depend not only on the cost of
labor but also on the cost of the other factors.
In the short run, volume of labor services is variable

Introduction

factors
In the long run, there are possibilities of substituting capital K for labor
E

Introduction

factors
In the long run, there are possibilities of substituting capital K for labor
E
This is precisely the purpose of the theory of labor demand: to study
the behavior of …rms when there are more than two factors of
production given the trade-o¤s between the number of its employees
and number of hours worked

Introduction
Most …rms make many hiring and separation decisions in a given year.
As a result the level of their workforce frequently changes.
The following …gures present results:
Net variations in employment within a …rm are for the most part much
more limited than its variations in hires and separations

Introduction
Even when their employment is shrinking on average over a period of
time, …rms are still hiring

Introduction
Even when their employment is shrinking on average over a period of
time, …rms are still hiring
The number of separations continues to be substantial in …rms
experiencing growth

Net employment growth, hires and separations

Net employment growth, hires and separations

Net employment growth, hires and separations - Evidence
for Portugal
Figure: Source: Carneiro et al. (2014)

Job and Worker Flows - Evidence for Portugal
Figure: Source: Quadros de Pessoal; Carneiro et al (2014)

Job and Worker Flows - Evidence for Portugal
Figure: Source: Carneiro et al (2014)

Determinants of labor demand in the short-run
Hypothesis:
Two inputs – labor and capital
Production function: q = f (E , K )

Hypothesis:
Labor is homogeneous (i.e., there is a single type of labor)

Hypothesis:
The quantity of labor that enters the production function is total
employee-hours (E number of workers*average number of hours of
work per worker)

Hypothesis:
work per worker)
q: total output

Hypothesis:
work per worker)
q: total output
E : number of workers [employee-hours]

Hypothesis:
work per worker)
q: total output
E : number of workers [employee-hours]
K : capital stock (aggregate of all physical inputs used in production)


Objective of the …rm: maximize pro…t (π)
π = pq wE rK
p: price at which the …rm can sell its output; w: price of labor (wage)
r : price of capital
In the short run:
VMPE = p.MPE
VMPE is the increase in total revenue generated by an additional worker
The …rm hires workers up to the point where the wage rate is equal to the
value of the marginal product of labor:
w = VMPE


In the case of labor, the …rm will continue to hire workers as long as
the marginal cost does not exceed the marginal bene…t
Contribution of a worker to the …rm’s pro…t

Positive one: Additional product in value (VMPE )
The …rm hires workers if VMPE w

In the case of labor, the …rm will continue to hire workers as long as
the marginal cost does not exceed the marginal bene…t
Contribution of a worker to the …rm’s pro…t

Positive one: Additional product in value (VMPE )
Negative one: Marginal Cost of Labour or Wage (w )
The …rm hires workers if VMPE w

Labor demand curve (short-run)
Plots the response of total employment to wage changes (keeping

capital constant)
It is the downward-sloping portion of the VMPE curve (below the

VAPE ) – the labor demand curve slopes downwards (law of
diminishing returns)
The position of the labor demand curve depends on the price of the
output – if the price increases, the demand curve shifts upwards

Determinants of labor demands in the short-run

Labor demand in the long-run
In the longer run, the …rm may replace part of its workforce with
machines or increase the number of its personnel and reduce its stock
of capital
Labor demand will then depend on the technical feasibility of these

operations and the price of the other inputs.

In the long-run, capital K can be a ‡exible factor

In the …rst stage, the level of production is taken as given and we look
for the optimal combination of capital and labor by minimizing the
total cost
We analyze substitution e¤ects and scale e¤ects and then deduce the
properties of the conditional and unconditional factor demands.


total cost
In the second stage, we look for the optimal production quantity so as
to maximize the …rm’s pro…t


total cost
1. Substitution e¤ects relate to the choice of one factor over another in
order to attain a given level of production


total cost
1. Substitution e¤ects relate to the choice of one factor over another in
order to attain a given level of production
2. Scale e¤ects have to do with the capacity to alter the level of
production while retaining the same proportions among the various
inputs

Example: a wage rate reduction

If there is a wage cut, the marginal cost of producing the output falls
=) production is scaled up increasing the quantities of all inputs (E
and K ) the …rm will use =) the …rm’s demand for labor increases
(scale e¤ect)
Labor becomes relatively cheaper (there is a change in the relative
prices of the inputs) – the …rm responds by changing its technology
preferring a more labor-intensive technology =) the …rms demand
for labor increases (substitution e¤ect)
w # =) scale e¤ect (E ") + substitution e¤ect (E ") =) labor
demand increases

Competitive markets

Non-competitive markets - Monopsony
A monopsony is a …rm that faces an upward-sloping supply curve of

labor
In contrast to a competitive …rm that can hire as much labor as it

wants at the going price, a monopsonist must pay higher wages in
order to attract more workers
Two types of monopsonistic …rms: a perfectly discriminating

monopsony and a nondiscriminating monopsony.

Non-competitive markets - Perfectly discriminating
monopsonist
A perfectly discriminating monopsony faces an upward-sloping supply

curve and can hire di¤erent wortkers at di¤erent wages
The labor supply curve gives the marginal cost of hiring
Pro…t maximization occurs at point A
The monopsonist hires the same number of workers as a competitive

market, but each worker gets paid his reservation wage


Non-competitive markets - Nondiscriminating monopsonist
A nondiscriminating monopsonist must pay all workers the same

wage, regardless of the worker’s reservation wage
The marginal cost of hiring exceeds the wage, and the marginal cost
curve lies above the supply curve
Pro…t maximization occurs at point A; the monopsonist hires EM

workers and pays them a wage of wM


Labor costs

Labor costs
Fixed versus Variable Labor Costs: costs that are invariant to the
number of hours of work (…xed costs) and costs that vary with the
number of hours of work (variable costs):
Hiring costs do not depend on the number of hours the newly-hired
employee will work (they are …xed costs – relatively to hours of work)

Labor costs
Insurance premia (e.g., insurance against workplace accidents) as long
as they are not computed as a percentage of the wage are also …xed
costs for the employer

Labor costs
Other types of non-wage compensation (e.g., use of company car and
other fringe bene…ts) are usually …xed costs

Labor costs
Other types of non-wage compensation (e.g., use of company car and
other fringe bene…ts) are usually …xed costs
Wages paid for normal or overtime hours of work vary with the number
of hours actually worked – they are variable costs

Labor costs
Classi…cation of …xed costs

Criterion: they occur once during the life of the employment
relationship (one-time) or multiple times (recurring)
Hiring costs are one-time costs
Insurance premia are recurring costs

Labor costs
Classi…cation of variable costs

The three major types of variable labor costs are:
Total wage (worker’s pay for work done during normal hours)
Overtime pay (total pay for overtime work, i.e., done over and above
normal hours)
Non-wage labor costs (e. g., employers’social contributions paid by
the …rm)

The costs of labor adjustments
Adjusting the size of the workforce entails costs. However, there is no

general consensus as regards the analytical representation of these
costs.
1. A typology:
Labor adjustment costs arise from variations in the volume of
employment and renewal of former employees.
2. Evaluating hiring and separation costs
3. Employment protection measures


costs.
1. A typology:
Gross changes and net costs


costs.
1. A typology:
US Data (Hamermesh, 1993) hiring costs greater than separation costs


costs.
1. A typology:
French Data (Abowd and Kramarz, 2003) hiring costs of skilled
workers greater than separation costs


costs.
1. A typology:
French Data (Abowd and Kramarz, 2003) hiring costs of skilled
workers greater than separation costs
Criteria: possibility of using contracts of limited duration, services of
agencies supplying temporary labor, administrative procedure, the
amount of advance notice, severance pay, etc.
Following a demand or supply shock, the optimum level of

employment falls from N (its current level) to N (π (N ) < π (N ))
Static labor demand theory assumes that changing the quantities of
the labor input has no costs. Because of that it concludes that …rms
will always be in a situation where the equality VMPE = w holds true
There are costs associated to hiring and …ring decisions – these are
labor adjustment costs (one-time …xed labor costs)
Hiring costs: posting job vacancies announcements, processing
applications, job interviews, tests, initial training,...


Firing costs: severance payments, administrative costs, lower
productivity following dismissal episodes due to reduced morale of
those remaining with the …rm


Firing costs: severance payments, administrative costs, lower
productivity following dismissal episodes due to reduced morale of
those remaining with the …rm
Costs of reorganizing production: changes in production due the
variation in the number of workers originate temporary productivity cuts

When there are costs of hiring and …ring (or costs of changing the
total number of workers), the employer may be willing to accept some
deviation between the desired and the actual number of workers
Such a deviation will be optimal whenever the cost of adjusting

exceeds the corresponding bene…t (π (N ) π (N )). Adjustment is
optimal only if the reverse is true
Labor is a quasi-…xed factor of production

The costs of labor adjustment
If adjustment is desired, it is necessary to choose how to implement it

– all at once or gradually?
The answer depends on how adjustment costs vary with the size of
adjustment – two polar cases:
Total adjustment costs do not vary with the number of workers being
hired or …red – adjustment costs are …xed

If adjustment is desired, it is necessary to choose how to implement it

– all at once or gradually?
The answer depends on how adjustment costs vary with the size of
adjustment – two polar cases:
Total adjustment costs do not vary with the number of workers being
hired or …red – adjustment costs are …xed
Adjustment costs increase at an increasing rate with the number of
workers being hired or …red – adjustment costs are convex



Recommended readings
Boeri, T., van Ours, J. (2021), The Economics of Imperfect Labor

Markets, chap. 1.
Cahuc, P., Carcillo, S., and Zylbergerg, A. (2014), Labor Economics,

Massachusetts Institute of Technology, chap. 2.

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Labor Demand

Economia do Trabalho () Labor Demand 2023/2024 1 / 37

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 2 / 37

See how …rms choose their factors of production

Analyze substitution between capital and labor

Study the e¤ects of the adjustment costs of labor

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 3 / 37

The theory of labor demand is deeply related to that of production

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 4 / 37

The theory of labor demand is deeply related to that of production

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 4 / 37

The theory of labor demand is deeply related to that of production

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 4 / 37

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 5 / 37

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 5 / 37

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 5 / 37

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 6 / 37

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 7 / 37

Figure: Source: Carneiro et al. (2014)

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 8 / 37

Figure: Source: Quadros de Pessoal; Carneiro et al (2014)

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 9 / 37

Figure: Source: Carneiro et al (2014)

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 11 / 37

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 11 / 37

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 11 / 37

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 11 / 37

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 11 / 37

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 11 / 37

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 12 / 37

Objective of the …rm: maximize pro…t (π)

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 13 / 37

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 14 / 37

Contribution of a worker to the …rm’s pro…t

The …rm hires workers if VMPE w

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 15 / 37

Contribution of a worker to the …rm’s pro…t

The …rm hires workers if VMPE w

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 15 / 37

Plots the response of total employment to wage changes (keeping

It is the downward-sloping portion of the VMPE curve (below the

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 16 / 37

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 17 / 37

Labor demand will then depend on the technical feasibility of these

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 18 / 37

In the long-run, capital K can be a ‡exible factor

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 19 / 37

In the long-run, capital K can be a ‡exible factor

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 19 / 37

In the long-run, capital K can be a ‡exible factor

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 19 / 37

In the long-run, capital K can be a ‡exible factor

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 19 / 37

Example: a wage rate reduction

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 20 / 37

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 21 / 37

A monopsony is a …rm that faces an upward-sloping supply curve of

In contrast to a competitive …rm that can hire as much labor as it

Two types of monopsonistic …rms: a perfectly discriminating

Economia do Trabalho (FEP, U.Porto) Labor Demand 2023/2024 22 / 37

A perfectly discriminating monopsony faces an upward-sloping supply

The labor supply curve gives the marginal cost of hiring

Pro…t maximization occurs at point A