AQA Specification focus:
‘The determinants of the elasticity of demand for labour.’
Introduction
Elasticity of labour demand measures how sensitive the quantity of labour demanded is to changes in the wage rate, influenced by several key economic determinants.
Understanding Elasticity of Labour Demand
The elasticity of demand for labour refers to the responsiveness of the quantity of labour demanded by firms when there is a change in the wage rate.
Elasticity of Labour Demand: The responsiveness of the quantity of labour demanded to a change in the wage rate.
This elasticity varies across industries, occupations, and time frames, depending on the conditions faced by firms.
The Determinants of Labour Demand Elasticity
AQA requires students to know the main determinants that influence the elasticity of labour demand. These include:
1. Labour Costs as a Proportion of Total Costs
If labour costs form a high proportion of total production costs (e.g., in labour-intensive industries like hospitality), demand for labour is likely to be more elastic.
When labour costs are small relative to total costs (e.g., in capital-intensive industries like oil refining), demand is usually inelastic.
2. Ease and Availability of Substitutes
Where it is easy to substitute labour with capital (machinery/automation), labour demand will be more elastic.
In industries requiring uniquely human skills that machines cannot replicate, demand for labour is likely to be inelastic.
3. Elasticity of Demand for the Final Product
The demand for labour is derived demand, meaning it depends on the demand for the goods and services produced by workers.
Derived Demand: The demand for a factor of production (such as labour) that results from the demand for the output it helps to produce.
If demand for the final product is elastic, any wage rise that increases costs will reduce output significantly, making labour demand more elastic.
If demand for the final product is inelastic, labour demand is more inelastic, since firms can pass higher costs onto consumers.
4. Time Period Considered
Short run: Firms may find it hard to adjust to wage changes due to fixed contracts or investment constraints, making labour demand inelastic.
Long run: Firms can adjust production processes, adopt technology, or relocate operations, making labour demand more elastic.
5. Flexibility of Labour
If workers are highly specialised, with limited substitutes available, labour demand tends to be inelastic.
Where workers are easily transferable between roles and sectors, labour demand will be more elastic.
6. The Level of Wages
At higher wage levels, firms are more sensitive to further wage increases, so demand tends to be more elastic.
At lower wage levels, firms may be less responsive, and demand is typically inelastic.
Diagrammatic Representation
In economics, the labour demand curve slopes downward, reflecting the inverse relationship between wage rate and quantity of labour demanded. The degree of elasticity is shown by how steep or flat the demand curve is:
A flatter demand curve = more elastic labour demand.
A flatter demand curve represents elastic labour demand: a small change in the wage rate causes a proportionally larger change in employment. Source
A steeper demand curve = more inelastic labour demand.
A steep demand curve depicts inelastic labour demand: employment changes little when wages change. Source
Layered Analysis of Determinants
To understand how the determinants interact, consider these layers of influence:
Industry structure: Labour-intensive versus capital-intensive.
Technology availability: Automation substitutes influence elasticity.
Market power: Firms with greater pricing power may show lower wage responsiveness.
Globalisation: The ability to outsource labour internationally increases elasticity.
Equation for Elasticity of Labour Demand
Elasticity of Labour Demand (EdL) = % Change in Quantity of Labour Demanded ÷ % Change in Wage Rate
% Change in Quantity of Labour Demanded = ((New Quantity – Old Quantity) ÷ Old Quantity) × 100
% Change in Wage Rate = ((New Wage – Old Wage) ÷ Old Wage) × 100
This equation helps quantify responsiveness, though in practice, exact values are often estimated rather than precisely calculated.
Key Points for Students
Elasticity is context-dependent: no single factor dominates in all industries.
Time horizon matters: adjustments are limited in the short run but greater in the long run.
Links to product demand: understanding derived demand is essential.
Policy implications: governments must consider labour demand elasticity when implementing wage policies, such as minimum wages or tax reforms.
A competitive labour market is drawn with wage on the vertical axis and labour (employment) on the horizontal axis. This orientation helps interpret elasticity in wage–employment changes. Source
FAQ
Industries that are labour-intensive with high wage costs, such as hospitality, retail, or textiles, often have elastic labour demand. A small wage rise significantly increases overall costs.
In these cases, firms may reduce staff quickly or substitute workers with part-time or temporary contracts. The ease of making such adjustments contributes to greater wage sensitivity.
In the short run, firms may struggle to change staffing levels due to contracts, hiring costs, or rigid production structures, making labour demand relatively inelastic.
Over the long run, firms can adjust by automating tasks, retraining workers, or outsourcing production abroad. These long-term adjustments create more elastic labour demand as firms respond flexibly to wage changes.
The availability of capital substitutes like automation or AI makes labour demand more elastic. If wages rise, firms can replace workers with machines to maintain output.
However, in sectors needing unique human skills—such as creative design or medical care—technology cannot easily substitute, so demand for labour remains relatively inelastic.
At high wage levels, increases represent a significant cost burden. Firms respond by reducing staff or substituting capital, making demand more elastic.
At low wage levels, additional wage rises form a smaller share of costs. Firms are less sensitive to these changes, so demand is more inelastic.
Globalisation increases firms’ ability to relocate production or outsource tasks abroad. This makes labour demand in domestic markets more elastic.
Firms can shift employment geographically if domestic wages rise, reducing reliance on local labour. However, in jobs requiring close proximity to customers (e.g., personal services), globalisation has little effect, leaving demand more inelastic.
Practice Questions
Define the term elasticity of demand for labour. (2 marks)
1 mark for recognising it measures responsiveness.
1 mark for stating it refers to the change in the quantity of labour demanded following a change in the wage rate.
Explain two factors that influence the elasticity of demand for labour. (6 marks)
Up to 3 marks for each factor explained (2 factors required).
1 mark for clear identification of a factor (e.g., labour costs as a proportion of total costs, ease of substitution, elasticity of product demand, time period, flexibility of labour, level of wages).
1 mark for explaining how the factor affects elasticity.
1 additional mark for developing the explanation, e.g., using an industry example or making the link to elastic/inelastic demand.
Maximum 6 marks: 2 × (1 identification + 1 explanation + 1 development).
