5-1. Suppose the labor supply curve is upward sloping and the labor demand curve is downward
sloping. The study of economic trends over a particular time period reveals that the wage recently
fell while employment levels rose. Which curve must have shifted and in which direction to
produce this effect?
If the supply curve does not shift, all wage and employment movements must occur along the supply
curve, so that the wage rate and the employment level must move in the same direction. Because the wage
went down while employment went up in the situation described in the question, it must have been the
case that the supply curve shifted outwards (to the right). We do not have enough information to
determine whether the demand curve shifted as well.
5-2. It takes time to produce a new economist, and prospective economists base their career decision
by looking only at current wages across various professions. Further, the labor supply curve of
economists is much more elastic than the labor demand curve. Suppose the market is now in
equilibrium, but that the demand for economists suddenly rises because a new activist government
in Washington wants to initiate many new programs that require the input of economists. Illustrate
the trend in the employment and wages of economists as the market adjusts to this increase in
Initially, the market is in equilibrium at a wage0wand an employment level of E .0The increase the
demand for economists results in a new equilibrium wage of w 1and a new equilibrium employment level
of E1. However, the demand for economists in the short-run is inelastic at E0, so the demand increase
simply leads to a rise in the wage of economists (as indicated by point 1). In the next period, students
believe this wage will persist and oversupply the market so that the cobweb leads to a new wage at point
2. In the next period, students undersupply (because the wage is too low) and the cobweb leads to a new
wage at point 3, and so on. Because of the relative elasticities of supply and demand (as drawn), the
cobweb is exploding and will never converge to a stable equilibrium.
D 1 3
E0 E1 Employment
5-3. Suppose the supply curve of physicists is given by w = 10 + 5E, while the demand curve is given
by w = 50 – 3E. Calculate the equilibrium wage and employment level. Suppose now that the
demand for physicists increases and the new demand curve is given by w = 70 – 3E. Assume this
market is subject to cobwebs. Calculate the wage and employment level in each round as the wage
and employment levels adjust to the demand shock. (Recall that each round occurs on the demand
curve – when the firm posts a wage and hires workers). What is the new equilibrium wage and
The initial equilibrium is given by 10 + 5E = 50 – 3E. Solving these two equations simultaneously
implies that w = $35 and S = ED= 5. When demand increases to w = 70 – 3E, the new equilibrium wage
is $47.5 and the equilibrium level of employment is 7.5.
Round Wage Employment
1 $55.0 5
2 $43.0 9
3 $50.2 6.6
4 $45.9 8.0
5 $48.4 7.2
6 $46.9 7.7
7 $47.8 7.4
8 $47.2 7.6
The table gives the values for the wage and employment levels in each round. The values in the table are
calculated by noting that in any given period the number of physicists is inelastically supplied, so that the
wage is determined by the demand curve. Given this wage, the number of economists available in the
next period is calculated. By round 7, the market wage rate is within 30 cents of the new equilibrium.
30 5-4. The 1986 Immigration Reform and Control Act (IRCA) made it illegal for employers in the
United States to knowingly hire illegal aliens. The legislation, however, has not reduced the flow of
illegal aliens into the country. As a result, it has been proposed that the penalties against employers
who break the law be increased substantially. Suppose that illegal aliens, who tend to be less skilled
workers, are complements with native workers. What will happen to the wage of native workers if
the penalties for hiring illegal aliens increase?
A substantial increase in the penalties associated with hiring illegal aliens will likely reduce the number of
illegal aliens entering the United States. The effect of this shift in the size of the illegal alien flow on the
marginal product (and hence the demand curve) of native workers hinges on whether illegal aliens are
substitutes or complements with natives. As it is assumed that natives and illegal aliens are complements,
a cut in the number of illegal aliens reduces the value of the marginal product of natives, shifting down
the demand for native labor, and decreasing native wages and employment.
5-5. Suppose a firm is a perfectly discriminating monopsonist. The government imposes a minimum
wage on this market. What happens to wages and employment?
A perfectly discriminating monopsonist faces a marginal cost of labor curve that is identical to the supply
curve. As a result, the employment level of a perfectly discriminating monopsonist equals the
employment level that would be observed in a competitive market (at E ) The imposition of a minimum
wage at wMIN leads to the same result as in a competitive market: the firm will only want tD hire E
workers as wMINis now the marginal cost of labor, buS E workers will want to find work at the minimum
wage. Thus, the wage increases, but employment falls.
E D E * E S Employment
31 5-6. What happens to wages and employment if the government imposes a payroll tax on a
monopsonist? Compare the response in the monopsonistic market to the response that would have
been observed in a competitive labor market.
Initially, the monopsonist hiMes E workers at a waMe of w . The imposition of a payroll tax shifts the
demand curve to VMP′, and lowers employment to E′ and the wage to w′. Thus, the effect of imposing a
payroll tax on a monopsonist is qualitatively the same as imposing a payroll tax in a competitive labor
market: lower wages and employment. (It is interesting to note that the same result comes about if the
payroll tax is placed on workers, so that the labor supply and marginal cost of labor curves shift as
opposed to labor demand.)
MC E S
VMP′ VMP E
5-7. An economy consists of two regions, the North and the South. The short-run elasticity of labor
demand in each region is –0.5. The within-region labor supply is perfectly inelastic. The labor
market is initially in an economy-wide equilibrium, with 600,000 people employed in the North and
400,000 in the South at the wage of $15 per hour. Suddenly, 20,000 people immigrate from abroad
and initially settle in the South. They possess the same skills as the native residents and also supply
their labor inelastically.
(a) What will be the effect of this immigration on wages in each of the regions in the short run
(before any migration between the North and the South occurs)?
There will be no effect on the North’s labor supply in the short run, so the wage rate will not change
there. In the South, labor supply will have increased by 5 percent, so the wage rate must fall by 5/(0.5) =
10 percent (recall that the elasticity of labor demand is -0.5, so a one percent decrease in wages would
have been generated by a 0.5 percent expansion of the labor supply). The new hourly wage in the South,
therefore, is $13.50 and total employment in the South is 420,000.
32 (b) Suppose 1,000 native-born persons per year migrate from the South to the North in response to
every dollar differential in the hourly wage between the two regions. What will be the ratio of wages
in the two regions after the first year native labor responds to the entry of the immigrants?
After the initial migration, we have seen that wages in the South are $13.50 while wages in the North are
$15. This difference leads 1,500 natives migrating from the South to the North in the first year.
Employment in the North after one year, therefore is 601,500. Moreover, as the elasticity of labor demand
in the North is -0.5 and employment has increased by 0.25 percent, the Nort