Question

(a) Using the firm’s one period profit maximization problem show what happens to the

quantity of labor hired after a rise in the real wage.

(b) What happens to the equilibrium level of labor and wages after a decline in the level of

technology? Use both the firm’s one period profit maximization problem and the labor

market graph.

Answer 1

(a)

A rise in real wages will increase the firm's input costs, lowering profitability. So firms will hire less labor, and quantity of labor demanded will fall, causing an upward movement along labor demand curve, increasing unemployment. In following graph, as real wages rise from w0 to w1, there is a movement from point A to point B with quantity of labor demanded decreasing from L0 to L1, causing unemployment equal to (L0 - L1).

(b)

A decline in technology will decrease labor productivity, so demand for labor will fall. The labor demand curve will shift leftward, decreasing real wage rate and employment. In following graph, LD0 and LS0 are initial labor demand and supply curves intersecting at point A with initial wage rate w0 and employment L0. As labor demand falls, LD0 shifts left to LD1, intersecting LS0 at point B with lower wage rate w1 and lower employment L1, causing unemployment of (L0 - L1).