Generic problem: Suppose that under a new law, all businesses must pay a tax equ

Question

Generic problem:

Suppose that under a new law, all businesses must pay a tax equalto 3% of their sales revenue. Assume that this tax is not passed onto consumers. Instead, consumers pay the same prices after the taxis imposed as they did before.

a) What is the effect of this tax on labor demand?

b) If the labor supply curve is unchanged, what will be the effectof the tax on employment and the real wage earned by workers?

Explanation / Answer

The tax causes MR to become less than MC (assuming the two wereinitially equal). With MC > MR, the companies will want todecrease production, and thus a) labor demand will decrease b) If labor supply remains unchanged, the decrease in labor demandwill cause both the real wage and employment to decrease.

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