Question

The equilibrium wage in the fast food industry in US is $10 per hour equilibrium quantity is 1,000,000 worker hours. This is the Benchmark Equilibrium; call it point E. This is a perfectly competitive market, where the demand and supply curves have regular shape. Please draw the benchmark equilibrium, which should lie at the intersection of the Demand and Supply curve. Suppose because of political action and worker unrest in this industry, government imposes a $18 minimum wage. At the minimum wage, employers want to hire 400,00 worker hours, but workers want to work 1,120,000 worker hours.

a. Show the minimum wage line on Graph 1. Clearly mark point E, the benchmark equilibrium point (E), and the new equilibrium point (call it F), with their co-ordinates. Please indicate the numerical level of unemployment on Graph 1 as well.

Suppose after imposition of the new minimum wage, illegal immigrants enter this specific labor market. Please note that the minimum wage continues to be at $18, where employers want to hire 400,00 worker hours

b. On Graph 1 show the new equilibrium after illegal immigrants enter this market. Call this new equilibrium M. Can you indicate the new level of unemployment on the graph (no math calculations are necessary)? How does this level of unemployment compare to the unemployment level in part a of this question?

Answer 1

Equilibrium in the labor market

Labor demand and labor supply

The labor market is a bit different from markets for goods and services.The reason behind this is that labor demand is a derived demand i.e labor is not desired for direct consumption like other goods but is desired for fulfilling the objective of producing goods and services.Labor demand is a means to an end and not an end in itself.It aids in producing output.Firms determine their demand for labor by the objective of profit maximization which in turn depends on demands for the goods and services it produces,ultimately seeking to produce the optimum level of output at lowest possible cost.

IN ORDER TO FIND THE EQUILIBRIUM QUANTITY AND PRICE OF LABOR,ECONOMIST GENERALLY MAKE SEVERAL ASSUMPTIONS;-

• The marginal product of labour(MPL) is decreasing.
• Firms are price takers in goods market as well as in the labor market i.e they can neither affect the price in goods market nor the wage rate in the labor market
• The supply of labor is elastic and increases with the wage rate
• Firms are profit maximizers.​​​​​​​​​​​​​​

The value of marginal product of labor (VMPL) is equal to the MPL multiplied by the price of the commodity the labor is producing.The VMPL represents the additional revenue that the firm can earn by employing one additional unit of labor i.e it is the marginal benefit to firm from an additional labor.According to the above assumption the MPL is decreasing as the quantity of labor employed increases and firms can only increase profit by hiring more labor upto the point where VMPL is greater than the cost of hiring labor i.e wage.The point at which VMPL is equal to the prevailing wage rate in the labor market is represented in figure1(in the attached image)

Supply of labour​​​​​​​

In perfectly competitive labor market,where wage rate is determined in the industry,rather than by individual firm,each firm is a wage taker.This means the actual equilibrium wage will be set in the market,and the supply of labor to the individual firm is perfectly elastic at the market wage rate.Labor supply curve is upwards sloping as the opportunity cost of leisure increases with a rise in wage rate.

Reasons for shift in labor demand curve

The labor demand can shift with change in any of the following

• ​​​​​​​Productivity of labor.
• The price of the product.
• Demand for the product.​​​​​​​

Reasons for shift in Labor supply curve

The labor supply can shift with a change in any of the following

• The length of the working week.
• Participation rate.
• Demographic factors such as migration,changes in age structure of the population.
• Qualifications and skills required.
• The length of training.

Markets are based on voluntary trades.In such markets,even after the imposition of minimum wage which is higher than the equilibrium wage,no one can force firms to hire more workers than it demands.As a result,the equilibrium quantity of labor traded in the market will be determined by how much the firms wish to buy,not by how much workers want to sell.(in such cases equilibrium in determined by the lesser quantity i.e labor supply or demand,whichever is lesser).