In Australia, and in other countries, we observe at any one time a wide distribution of hours worked per week. We develop a cost-minimising model to explain employer choices over the number of employees and their hours of work. An important finding is that hours of work and the number of employees are not perfect substitutes. We show that this has important implications for the way economists model labour demand and measure productivity. We show that estimates using total hours worked as the measure of labour input implicitly assumes perfect substitution of persons and hours and results, inter alia, in an overestimation of the rate of labour and multifactor productivity growth in Australia and especially in the period prior to the so called ‘productivity slow-down’.
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