Question

Inequality. There are two types of labor in the economy: skilled labor Lsk and unskilled labor Lunsk. Skilled and unskilled labor earn different real wages: Wsk/P and Wunsk/P. The production function is given by

Y =Aln(Lsk)+4ln(Lunsk).
The parameter A reflects technology. The supply of skilled labor is given by LSsk = Wsk/P and the

supply of unskilled labor is given by LSunsk = 10.

1. (A) Derive the demand functions for skilled and unskilled labor, LDsk and LDunsk. Sketch the equilibrium graphically on two diagrams: the market for skilled labor and the market for unskilled labor. Don’t worry about the precise shape of the curves.

2. (B) The level of technology A was 25, and during the last year it went up to 36. Find the original and the new equilibria (you need to calculate two levels of employment and two real wages). What is the direction of change in GDP? Re-draw the diagrams from part B to show how the increase in A affects the equilibrium on both markets. Clearly label all axes, shifts, and curves.

3. (C) As the American economy has been growing, income inequality has been rising too. In the context of this problem, is inequality in incomes of skilled an unskilled workers a “fair” outcome? If you were a policymaker, would you want to eliminate this kind of inequality?

Answer 1