Question

Suppose that the government subsidizes employment. That is, the government pays the firm s dollars for each hour of labor the firm hires. In a graph that illustrates total revenue and total cost, illustrate the e§ect this subsidy has on the proÖt maximizing level of labor hired. Does it increase or decrease the labor?

Answer 1

When the government decides to subsidise employment, it is in a way encouraging the firms to employ more labour than the present. So by paying a part of the wages the burden from the firms is reduced. Subsidy reduces the cost of hiring.

In the diagram shown above we see that if the government provides $ 1 employment subsidy to the employer or the firm. ,the wage for the worker increases from w0 to w1

The demand curve shifts up by the amount of subsidy which is the cost by which the hiring per worker has reduced. So demand curve increases from D0 to D1.

This leads to shift in the labour market equilibrium from A to B. Also on this new demand curve the more employment increases from E0 to E1 .

The wages received by the workers increase from w0 to w1 and the amount the firms pay ie the cost of employment reduces from w0 to w1-1 .

So the revenue increased because of increased labour but since the wage is subsidised the cost to the firm is less.

The amount of labour increases as the employment increases from E0 to E1.

So the government subsidy is beneficial for both the labour and the firms.