Question

Urban Economics- Urban Labor Market: Employment and Wage

Q1-Q2 are based on the following conditions.

1) Consider the effect of a natural disaster on an urban economy. In the initial equilibrium, total employment in the city is 100,000 workers and weekly wage rate is $1000. The price elasticity of supply of labor is 3.0 and the price elasticity of demand for labor is -2.

Suppose a typhoon reduces labor supply (a horizontal shift of the supply curve) by 10,000 workers immediately after the disaster. Which of the following statements is correct?

a) The new equilibrium weekly wage is $1,040.

b) The new equilibrium weekly wage is $980

c) The new equilibrium employment is 96,000

d) The new equilibrium employment is 104,000

2) Suppose the typhoon not only reduces labor supply but also decreases the labor demand by 10,000 workers. Which of the following statements is correct?

a) The new equilibrium weekly wage is $1000

b) The new equilibrium weekly wage is $980

c) The new equilibrium employment is 94,000

d) The new equilibrium employment is 88,000

Answer 1

1) Note that when supply curve shifts, we use a formula

% rise in the wage rate = % fall in the supply / (demand elasticity + supply elasticity)

= (10000*100/100000) / (3 + 2)

= 2%

Hence wages would be higher by 2% to reach 1000*1.02 = 1020. Now at original wage of 1000, employment demanded is 100,000. An increase in wage rate by 2%,reduces employment by 2%*2 = 4%. Hence new employment is 100000 - 100000*4% = 96000. Select C)

2) Since demand and supply shift by same size, equilibrium wage is unchanged and is fixed at $1000. Select A)