Question

Graph the market for an urban labor market for the city of Economica. Assume labor markets are clear.

a) Suppose the local government imposes a tax on business. Graph the effect.

b) Suppose the local government uses the tax to open a series of new museums. How might this affect the labor market? Graph the effect.

Answer 1

In each graph, wage rate (w) & employment (L) are measured vertically & horizontally respectively. D0 & S0 are initial demand & supply curves of labor, intersecting at point A with initial wage rate w0 & employment Q0.

(a) A tax on business will decrease firm profits, so producers will lower production and output. Demand for labor will fall, shifting labor demand curve leftward, decreasing both wage rate and employment. In following graph, as D0 shifts left to D1, it intersects S0 at point B with lower wage rate w1 and lower employment Q1.

(b) When government uses the tax to open new museums, demand for labor (by government) rises and labor demand curve shifts to right, raising wage rate and raising employment. In above graph, as D1 shifts right to D2, it intersects S0 at point with higher wage rate w2 and higher employment Q2 (However, it is possible that decrease in labor demand by firms exactly equals the increase in labor demand by government, therefore equilibrium may be restored at point A).