7.2 Effect on labour market, changes in factor price

Question 1

What are the 2 types of technological change which affects labour market?

Answer 1

1. Product demand shifts caused by invention of products
2. Change in production process caused by invention of new processes or inputs

Normally focus on second one (automation)
- Many changes showed in data may be caused by first, and many consequences may be similar

Question 2

How do we model automation?

Answer 2

Y = f(L,K)

• Represent function with isoquants - combinations of K and L

Properties:
- Downward sloping
- Dont intersect
- Higher isoquants have higher Y values
- Convex to the origin

Slope of an isoquant is the change in capital / change in labour
( MPL / MPK ) OR (DY/DL / DY/DK)

The absolute value of this slope is the marginal technical rate of substitution
- Isoquants imply a diminishing MRS between L and K

Question 3

What are isocosts

Answer 3

Show the firms production costs:

C = wL + rK

• Isocost connects all points with equal costs

Rearrange in same (K,L) as the isoquant, we get

k = c/r - w/r*L

Intercept is C/r - amount capital firm uses if L = 0
- Slope is the ratio of input prices

Question 4

At what point are costs minimised? What does this NOT imply?

Answer 4

At the point of tangency, where slopes are equal:

MPL/MPK = w/r

Means last £ spent on labour is as valuable as the laast £ spent on capital

MPL/w = MPK/r

Profit maximisin firms minimise costs, but doenst imply profit maximisation:
- Determined by MC = MR condition

Question 5

How does the model relate to technological change?

Answer 5

Tells us how many workers and capital a firm uses given
- Available technology
- Price of L and K

Question 6

How can we add technological change to the model?

Answer 6

• Simplest idea is that technological change is relative to factor prices, but this does not capture the most important feature of technology
• Technology also changes what we can produce from a given set of inputs and how we can substitute one input for another
• In other words, technology changes the production function

Increase in technological change:
- Interest rates go down, isocost slope is steeper - substitutes labour for capital, substitution effect

• Inputs cheaper, firm expands production, shifts isoquant out - new isocost tangental to new isocost - scale effect (income effect)

Both mean using more capital - the scale effect increases labour but the substitution effect does not
- Size of the effect is dependents - scale could be bigger

Dependent:
- Elasticity - depends on curvative/elasticity of isoquants
- How easily firms can replace workers with machines

Question 7

How does this respond when isoquants are perfect substitutes or complements

Answer 7

Perfect substitutes:
- Isocost unitary negative correlation, isoquant below it

If K > L, firm sacks all L and moves from maximum labour and substitutes to K
- Labour loses out

Perfect complements
- A fixed K:L ratio
- Tangency point cannot change if prices change
- Technological change good for workers as it drops interest rates, makes it pivot in favour of labour
- Also known as the Leontif production function

Question 8

How do you calculate the elasticity of substitution? What do different values indicate?

Answer 8

Responsiveness of factor demand to change sin factor prices:

(delta) = (%change in K/L) / (%change in w/r)

delta > 0 since if w/r rises then K/L cannot fall

delta = 0: perfect complements

delta = infinity: perfectly substitutes

delta = 1: unitary

0 < delta < 1 : elastic

1 < delta < infinity : inelastic

Question 9

How do you calculate factor demand with many inputs?

Answer 9

• Straightforward to extend basic model to incorporate many inputs
• e.g. using skilled and unskilled labour

Production function now:

Y = f(X1,X2,…,Xn)

The effect of a change in price of input j on input i depends on the size of substitution and scale effects

for example:
- Computers cheaper, firms substitute away from workers
- OUtput increases so firms use more computers and workers

Question 10

How do you calculate cross elasticity of demand

Answer 10

(delta)ij = %change in xi / %change in pj

If positive they are substitutes

If negative they are complemenets

Question 11

What is the capital-skill complementary hypothesis?

Answer 11

Unskilled labour and machinery often thought to be substitutes
- If capital is cheaper, firms use less unskilled labour, deltaij > 0

Skilled labour and machinery often thought to be complements
- If capital gets cheaper, firms use more skilled labour deltaij < 0

Might seem obvious that technological change is a threat to unskilled workers, however:
- Technological change not always and everywhere substitute for unskilled workers
- Scale effects may be very important