The Substitution Effect and a Decrease in Employment - Speech or Presentation Example

In the long run, a decrease in the price of capital will lead to an increase in labour units. This is because the proportions have a substitution effect. The total effect will be less capital and more labour employment. According to the substitution effect, I would expect a company to have a high own wage elasticity of demand if the other factors of production such as capital can easily be used as substitutes for labour. This would make it easy for labour to be reduced or increased depending on its substitute’s quantities.

If the product being produced in the industry has high price elasticity, then it means that the labour elasticity of demand will also be high. If an industry is producing coffee and the elasticity of demand for coffee keeps changing, then the own wage labour rate will also change relative to the elasticity of demand for the product. When all the other factors of production have a high elasticity of demand, then it also means that the labour elasticity of demand will be high thus elastic. If a company’s capital demand keeps changing for example, then it means even labour demand will change as the two are co-related.

A company will only be able to hire what it can pay for thus the elasticity. If the total cost of production of a company is highly contributed by labour, then the labour elasticity of demand will tend to be highly elastic. This is a scale effect that means that the more labour in the industry contributes highly to more total costs in production, the more the company is likely to demand labour. If the product cost is low for example and the company requires to spend less on production, they will cut on labour because it has the bigger percentage hence the elasticity.