Question

These questions will usually require you to do several comparative statics exercises and compare the outcomes. I recommend you read the full question before answering.

1. Describe how firms determine their labor demand and how workers decide how many hours to supply to the labor market.

2. Consider a universal basic income. How would this change the labor supply ? (you do not need to worry about how the universal basic income will be financed). How would wages and the number of employed workers change compared to the situation of question 1 ?

3. Compared to question 2, what happens if the universal basic income needs to be financed by taxing firms. How would wages and the number of employed workers change?

Answer 1

1) Apart from making output and pricing decisions, firms also have to determine how much of each input to choose. The three most common are land, labor, and capital.

The demand and supply of labor are determined in the labor market. The participants in the labor market are workers and firms.

Workers supply labor to firms in exchange for wages. Firms demand labor from workers in exchange for wages.

The firm's demand for labor is a derived demand; it is derived from the demand for the firm's output. If the demand for the firm's output increases, labor demand increases and will hire more workers and if the demand for firm's output decreases, labor demand decreases.

An individual's supply of labor depends on his preferences of consumption goods and leisure time. However, in choosing between these, a person faces some constraints

a) The person has a limited time of 24 hours per day for work or leisure.

b) The person income is limited by the market wage rate.

2) If there is some universal basic income, people will demand higher wages for doing work. Also, they will spend their more time in leisure. Therefore, if the firm wishes to hire more workers they have to offer higher wages and labor supply will fall because people already have money and they will spend more time on leisure activities.

3) If universal basic income is financed by taxing firm then the firms will charge higher prices from customers, which in turn decreases the real income in hands of people.

Therefore people will search for work and no. of workers increases in the market as we know the supply of labor increases the wage falls.