7. (2.5 pts) The following figure shows the labor demand curve, LD1, and labor s

Question

7. (2.5 pts) The following figure shows the labor demand curve, LD1, and labor supply curve, LS1 in a market where the quantity of labor is measured in millions. A month later, the labor demand curve shifts to LD2 Wage (S) 90 80 60 50 40 30 20 10 10 20 30 40 50 60 70 80 a. (1 pt) Refer to the figure above. If there is downward wage rigidity in the market, what will the b. (1 pt) Refer to the figure above. If the wage is flexible, what will the level of employment, the c. (0.5 pt) When is the reduction in employment the largest, when the wage is flexible or when the level of employment, the level of unemployment, the employment rate, and the unemployment rate be after the demand curve shifts to LD2? level of unemployment, the employment rate, and the unemployment rate be after the demand curve shifts to LD2? wage is downward rigid? Briefly explain why

Explanation / Answer

(a) Free market equilibrium wage rate is $50 and employment is 40 million (at intersection of LD1 and LS1). With downward wage rigidity, wage cannot fall below $50.

When labor demand falls to LD2, the quantity of labor demanded for $50 wage rate is 20 million. This is the new level of employment. Quantity of labor demanded for $50 wage rate is 40 million, so unemployment is (40 - 20) = 20 million.

Employment rate = 20 million / 40 million = 0.5 = 50%

Unemployment rate = 20 million / 40 million = 0.5 = 50%

(b) With flexible wage, new market equilibrium wage rate is $40 and employment is 30 million (at intersection of LD2 and LS1).

Employment rate = 30 million / 40 million = 0.75 = 75%

Unemployment rate = (40 - 30) million / 40 million = 10 million / 40 million = 0.25 = 25%

(c) Reduction in employment (i.e. unemployment) is largest with downward rigid wage rate. This is because wage rate being fixed at $50, a surplus arises in labor market where more workers are willing to work than are demanded, leading to higher unemployment.

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