Question

In the course of producing its output, a firm causes pollution. The government passes a law that requires the firm to stop polluting, and the firm discovers that it can prevent the pollution by hiring x workers for every worker that is producing output. That is, if the firm hires N workers, then xN workers are required to clean up the pollution caused by the N workers who are actually producing output. Determine the effects of the pollution regulation on the firm’s profit-maximizing choice of labour input and on the firm’s labour demand curve.

Answer 1

In the course of producing its output, a firm causes pollution. The government passes a law that requires the firm to stop polluting, and the firm discovers that it can prevent the pollution by hiring x workers for every worker that is producing output. That is, if the firm hires N workers, then xN workers are required to clean up the pollution caused by the N workers who are actually producing output. This means that to produce the same level of output with cleaning now the firm requires more labor inputs than the previous level.

As we know that Profit is maximized at the level of variable input where the MVP = MIC, that is, where the value of the additional output produced by using one more unit of variable input is equal to the cost of that last unit of variable input. So in the above example Marginal incremental cost is increasing because extra unit of labor to produce output also requires extra unit of labor to cleanup who is not producing output and the Marginal labor product is diminishing.

Now since more labors are needed to produce the same level of output so the firm's demand for labor will increase and its labor demand curve will shift to the right.