Question

4. (12-points). This question has parts (a), (b) and (c) a) Assume the labor market is in equilibrium. If the price of workers' output increases and the working age population decreases, explain what happens with demand and/or supply of labor and to the equilibrium wage and equilibrium number of workers? b) True, False, Why? The unemployment caused by the minimum wage law is always equal to the number of those who lose their jobs. c) True, False, Why? As the economy falls into a recession, unemployment decreases, it is higher than at peak but lower than at bust.

Answer 1

a) The answer to this question can be obtained by assessing the scale and the substitution effect of labour. Let us consider the first part, where the price of worker's output increases. For analysing this effect, it is important to realise that labour demand is essentially a derived demand. This means, the demand for labour is derived as a rsult of the demand for the goods or services that the labour produces, and not intrinsically for the demand for labour. Thus, if the price of the outpout of the workers, which means the price of the goods they produce increases, then the demand for that good will reduce. This means that the demand for labour required to produce the goods will also reduce, and in turn employment of labour force will reduce. This is known as the scale effect of labour demand. The second factor to analyse is the decrease in the working age of the population. If the working age of the population decreases, this means more labour is available for employment. As more people enter the labour force and the age of retirement is still held constant, this will cause excess supply of labour in the market.

The effect of these two factors on the equilibrium wage and number of workers can be obtained in the form of a graph. The demand curve will shift to the left (from D1 to D2) and the supply curve will shift to the right (from S1 to S2). Depending on the degree of the shift, the quantity of workers will be determined. If the demand curve shifts equally as the supply curve, the number of workers will remain the same, in the graph as L. If the demand curve shifts more (less) than the supply curve, then the number of workers employed will reduce (increase) from the pre-existing level. The level of wages, in every case, will reduce, as reflected in the graph, from W1 to W2. These changes have been summed up in the graph below -

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b) False.

To analyse this, consider the following graph. Here, D indicated the demand curve for labour and S indicated the supply curve for of labour. The market equilibrium conditions are established as - equilibrium wage rate at W and equilibrium level of employment at L. If the minimum wage is set above W, i.e. at Wm then the level of labour demand (and hence level of employment) reduces to L1 and the level of supply increases to L2. Thus, all the workers between L1 and L2 are unemployed (indictaed in the graph as distance AB) In this, the number of people who lose their jobs is L1-L. These people will be unemployed. But along with these, workers in the segment L-L2 who are new entrants into the labour force (because of minimum wages, the wage rate has increased and it has become profitable for them to enter the labour force now) will also come in the category of the unemployed.

Wages Detrtemployment) Excers Supply - 7- Quantity of labour

c) False.

When the economy is in recession, the level of unemployment is higher. This is because recession means low purcahsing power for people and hence low demand for goods and services. This means low production. Low production means less labour demand and thus, less employment or more unemployment. More unemployment again means low purchasing power and hence low demand for goods and services, and the cycle continues. So, unemployment is low at peak and high at bust.