Question

Use the substitution effect, scale effect, and labor demand elasticity to explain why an increase in the wage rate for coal miners will likely create more unemployment in the long run than in the short run.

Answer 1

Substitution Effect means the substitution of labor with machinery. As the wage rate for coal miners increases, there would be more labor force entering the coal mine industry as they get attracted to high wages. In the long run, once everything gets automated labor force would be substituted by machinery and thus more labors would be sacked and thus it would create more unemployment in the long run.

Scale effect means as there will be large scale production the average cost of production comes down. As the wage rate increases, there would be less labor force hired by the employers and thus the level of production comes down. This in turn would increase the price of the coal leading to less demand in the market. As a result there would be high level of unemployment in the long run due to less demand of coal in the market.

Labor demand would be more elastic when the firm can substitute the labor quickly. As the wage rate increases, the employer would substitute the labors with machinery in the long run as they get sufficient time to substitute. This in turn would lead to higher level of unemployment in the long run.