How Elastic is the Demand for Labor?

32 Pages Posted: 26 May 2004 Last revised: 8 May 2022

See all articles by Kim B. Clark

Kim B. Clark

Harvard Business School; National Bureau of Economic Research (NBER); Brigham Young University Idaho

Richard B. Freeman

National Bureau of Economic Research (NBER); University of Edinburgh - School of Social and Political Studies; Harvard University; London School of Economics & Political Science (LSE) - Centre for Economic Performance (CEP)

Date Written: 1979

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

Clark, Kim and Freeman, Richard B., How Elastic is the Demand for Labor? (1979). NBER Working Paper No. w0309, Available at SSRN: https://ssrn.com/abstract=260494

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