Question

5. Suppose the supply curve of physicists is given by w = 10 +5E, while the demand curve is given by w= 50 - 3E. a) Calculate the equilibrium wage and employment level. Calculate the labour demand elasticity at the equilibrium. Suppose now that the demand for physicists increases to w= 70 - 3E. What is the new equilibrium wage and employment level? b) Assume the market is subject to cobwebs. Draw a graph to illustrate the wage and employment level adjusting to the demand shock. Calculate the wage and employment level in each round up to round 6. (Round 0 is the old equilibrium.)

Answer 1

SOLUTION:-

(a)

(i) Solution :- At equilibrium, Supply = Demand.

10 + 5E = 50 - 3E

5E + 3E = 50 - 10

8E = 40

E = 5. (40 / 8)

W = 10 + 5 * 5 (Put the value of E = 5 in supply curve equation W = 10 + 5E).

W = 10 + 25

W = 35.

Conclusion :- Equilibrium wage level (W) = 35 and equilibrium employment level (E) = 5.

(a)

(ii) Solution :- W = 50 - 3E (Demand curve equation)

3E = 50 - W

E = (50 / 3) - W / 3

Accordingly, ΔE / ΔW = (-) 1/3

When W = 35, E = 5.

Labor demand elasticity at equilibrium = - ΔE / ΔW * W / E

= - (-) 1 / 3 * 35 / 5

= 1 / 3 * 7

= 2.33

Conclusion :- Labor demand elasticity at equilibrium = 2.33 (Greater than 1)

(a)

(iii) Solution :- Calculation of new equilibrium wage level (W) and employment level (E) :-

At equilibrium, Supply = Demand.

10 + 5E = 70 - 3E

5E + 3E = 70 - 10

8E = 60

E = 7.50. (60 / 8)

W = 10 + 5 * 7.50 (Put the value of E = 5 in supply curve equation W = 10 + 5E).

W = 10 + 37.50

W = 47.50

Conclusion :- Equilibrium wage level (W) = 47.50 and equilibrium employment level (E) = 7.50

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