How Well Have Rural and Small Metropolitan Labor Markets Absorbed Welfare Recipients?. Assumptions of Elasticity of Labor Demand and Labor Supply

04/01/2001

Our assumption is that welfare reform will have the largest effect on the low-skill labor market. Hence, the relevant elasticities of labor demand and labor supply are those for low-skill labor. Bartik presents a summary of elasticity estimates used in studies that examine the effect of welfare reform on wages and displacement.(37) The three studies cited in the exhibit (Mishel and Schmitt,(38) Holzer,(39) and Bernstein(40))used a labor demand elasticity of -0.3. Holzer and Bernstein used a labor supply elasticity of 0.4; Mishel and Schmitt used a labor supply elasticity of zero. All three studies repeated their calculations for alternative labor demand and labor supply elasticity assumptions.

Because elasticities for different types of labor can vary, it is necessary to use an elasticity estimate for workers who are similar in characteristics to welfare recipients. The labor demand estimates used in the studies cited above are taken from the minimum wage literature. The labor supply estimates used in these studies are taken from the literature on the decline in employment among low-skill adult males in the 1980s.

Based on these studies, we used a labor demand elasticity of -0.3 and a labor supply elasticity of 0.4. We were not able to find any studies that compared the differences in the elasticities across rural and urban areas. We were also not able to find any studies that compared the differences in the elasticity of labor supply before and after welfare reform.

Assumptions about the elasticity of labor supply and labor demand are critical to our analysis. As was discussed in Section 4.A and will be discussed in more detail in Chapter 5, the elasticity assumptions are instrumental in determining the size of the demand and supply shifts from the employment and wage data that we collected. Therefore, we used alternative labor demand and labor supply elasticities to test the sensitivity of our results to the elasticity assumptions. These results are presented in Appendix D. We found that our basic findings are not affected much by reasonable changes in the elasticities as a result of the small size of the increase in employment due to welfare reform relative to the low-skill labor market.