Question

22. Consider a labor market with two sectors denoted by A and B.

The demand and supply curves for labor in sector A are given by the equations

Demand: LD A = 20 − W,

Supply: LS A = W.

The demand and supply curves in sector B are given by the equations

Demand: LD B = 40 − 2W,

Supply: LS B = 2W.

22a. Find the market-clearing wage and employment level in each sector.

22b. Is it likely that the unemployment rate will be zero at the market-clearing value of the wage? If not, how would you categorize this unemployment?

22c. Suppose that the demand for the product produced in sector B increases at the expense of the product in sector A. As a result the demand for labor in sector A becomes LD A= 15 −W , while the demand in sector B becomes LD B= 45 − 2W. If W denotes the real wage, and the real wage in sector A is inflexible downward, how many workers will be unemployed in sector A? What will happen to the real wage and employment level in sector B?

22d. What adjustment in the supply of workers in each sector would eliminate the unemployment in sector A? How would this affect wages and employment in sector B?

22e. What factors tend to inhibit these adjustments?

22f. Assuming the necessary adjustments cannot be made, how would you classify this type of unemployment?

Answer 1

We are given the following information about the labour market.

Demand: LDA = 20 − W,

Supply: LSA = W.

Demand: LDB = 40 − 2W,

Supply: LSB = 2W.

22) a) At the market clearing wage we have Labour demand = Labour supply.

For sector A we have, 20 – w = w;   or, wa* = 10

So, La* = 20 – 10 = 10

For sector B we have, 40 – 2w = 2w;   or, wb* = 10

So, So, Lb* = 2*10 = 20

b) It is unlikely to have zero unemployment rate even at the market-clearing wage. A market-clearing wage just signifies the equilibrium between the two demand and supply forces. There can be people who are voluntarily unemployed or there can be frictional unemployment where people are in-between jobs.

c) Now, LD’A= 15 −W and LD’B= 45 − 2W

we saw wa* = 10. If this wage is inflexible, at this wage LD’ A= 15 −W = 15 – 10 = 5

However, La* = 10

So, 5 workers will be unemployed in sector A.

For sector B, we have, LD’B= 45 − 2W = 45 – 2*10 = 25

And Lb* = 2*10 = 20. Therefore, there will be excess supply of workers.

If wages are allowed to adjust freely, 45 − 2W = 2W will imply w higher wage of 11.25.

d) If 5 workers from sector A comes to sector B, the unemployment problem will be solved. This will decrease the wages and increase the employment in sector B.

e) Various structural, social and political conditions prevent from this happening such as the follows.

• Workers in sector A are not perfect substitute for workers in sector B
• Political motivation
• The opportunity cost of shifting is too high
• Inconvenience of unfamiliarity

f) It can be classified as structural unemployment.