Question

A firm uses skilled labor, unskilled labor, and capital, and is initially in equilibrium. Suppose that the wage paid to unskilled labor falls, and that unskilled labor is a substitute in production with both skilled labor and capital. Depict in separate graphs of (a) capital and unskilled labor and (b) capital and skilled labor how the original equilibrium choices change in response to the decline in wages paid to unskilled workers. What are the expected impacts on the wage and employment level for each group of worker, and why? How does this factor into the growth of inequality in recent decades in the United States?

Answer 1

a) The following picture shows how the decrease in wages in unskilled market affects the quilibrium in both, the skilled and unskilled market.

Unskilled: As the wages fall the unskilled labor will reduce the supply of labor and this will lead the wage rate to high. As the same substituion effect will take place. The demand reduces as the wages of the particular market increases. This will rather be invested in the skilled labor market.

Skilled: The increase in demand will lower the wage rates but you will see rise in the supply of skilled labors. The wage will however decline due to increased supply.

The increasing gap between skilled and unskilled labor in US is very evident. The fact that immigration is a problem in the country for past decade is now obvious. This is actually due to the increase income inequality in the country, and also the cause of it.