Question

Wage Subsidy for fast food workers. For this entire problem, assume that the labor supply curve is very wage-inelastic, and that the labor demand curve is downward sloping but relatively wage-elastic, and the labor market is competitive. a. (3 points) Draw a supply and demand diagram to show this labor market with a highly elastic labor supply curve and a relatively inelastic labor demand curve. Label your diagram carefully. b. Senator R. McDonald (D-NY) proposes $1 per hour wage subsidy to workers in fast food “to help low-wage workers.” In your diagram above, show the effect of this subsidy on the fast food labor market and answer the following (no explanation needed for this part). Does employment in fast food rise or fall as a result of the subsidy? Does the “employee’s wage” (including the subsidy) rise or fall?______________ Does the “employer’s wage” (the actual cost to the employer of an hour of labor) rise or fall as a result of the subsidy?_____________ c. Who wins and who loses from this program? Explain. Make sure your answer to part c is consistent with your answers to parts a and b.

Answer 1

Answer: Assuming that the labor supply curve is very wage-inelastic, and that the labor demand curve is downward sloping but relatively wage-elastic, and the labor market is competitive.

a)

Workers prefer to work when the wage is high, and firms prefer to hire when the wage is low. Labor market equilibrium “balances out” the conflicting desires of workers and firms and determines the wage and employment observed in the labor market. Equilibrium in a competitive labor market is shown below. The figure illustrates the familiar graph showing the intersection of labor supply (S) and labor demand (D) curves in a competitive market. The supply curve gives the total number of employee hours that agents in the economy allocate to the market at any given wage level; the demand curve gives the total number of employee-hours that firms in the market demand at that wage. Equilibrium occurs when supply equals demand, generating the competitive wage w * and employment E * . The wage w * is the market-clearing wage because any other wage level would create either upward or downward pressures on the wage; there would be too many jobs chasing the few available workers or too many workers competing for the few available jobs. Once the competitive wage level is determined in this fashion, each firm in this industry hires workers up to the point where the value of marginal product of labor equals the competitive wage. The first firm hires E1 workers; the second firm hires E2 workers; and so on. The total number of workers hired by all the firms in the industry must equal the market’s equilibrium employment level, E *.

The labor market is in equilibrium when supply equals demand; E* workers are employed at a wage of w*. In equilibrium, all persons who are looking for work at the going wage can find a job. The triangle P gives the producer surplus; the triangle Q gives the worker surplus. A competitive market maximizes the gains from trade, or the sum P Q. Dollars.

b) Now, Senator R. McDonald (D-NY) proposes $1 per hour wage subsidy to workers in fast food “to help low-wage workers.

The employment in the fast food falls due to subsidy.

The employee’s wage including the subsidy remains same.

Yes, the actual cost to the employer of an hour of labor rises as a result of subsidy.

c) The employee loses and the employer wins from this program.