Question

Consider the markets for low-skilled and high-skilled labor.

a. Suppose the government introduces a subsidy to the employment of low-skilled workers physically paid to firms. (For simplicity, assume the government pays firms some amount for each low-skilled worker they hire.) How will the subsidy affect the employment of low-skilled workers, the wage low-skilled workers receive, and net of-subsidy wage for low-skilled workers paid by firms? Will this policy tend to increase, decreaseor have no effect on income inequality (or is it not possible to tell)?

Suppose some low-skilled workers get more education , and so become high- workers. How will this development affect the employment and wages of low-skilled and of high -skilled workers? Will it tend to increase, decrease , or have no effect on income inequality (or is it not possible to tell)?

Answer 1

(a) At the point, when government provides a subsidy with the employment of low skilled laborers which is being paid to the organizations, at that point this will lessen the expense of recruiting low skilled labors of the firm. Hence, as there is a fall in the cost of hiring low skilled workers because of subsidy then as a result the demand for low skilled workers by the firms increases in an economy. This will be shown by the following diagram:

Above diagram shows that the initial equilibrium is at point E1, where the equilibrium labor employment is L1 and the equilibrium wage rate is w1. An increase in the demand for low skilled workers will lead to shift the demand curve of labor rightwards from DD to DD'. This shift in the demand curve will lead to increase the equilibrium level of employment to L2. The net of subsidy wage that is paid by the firms to the low skilled workers decreases to ow'. The policy will expect to diminish income inequality as wages of low skilled labors will increment alongside increment in their employment. In this manner, the gap between low skilled workers and high skilled workers will diminish in the economy.

(b) When low-skilled workers get more education and become high skilled workers, then as a result there is a decrease in the supply of low skilled workers in the labor market (for low skilled workers). Therefore, this will lead to shift the supply curve of low skilled workers leftwards from SS to SS'. This shift in the supply curve will lead to increase the equilibrium wage rate and decrease the level of employment. In the market for high skilled labor, there is a rise in the level of employment and a decrease in the level of real wage rate.

In this manner, the gap between low skilled workers and high skilled workers will diminish in the economy and results in a reduction of income inequality.