Question

2. Last summer, Russia experienced a significant drought, which lowered the marginal product of labor. How would that affect the equilibrium in the labor markets? Show graphically.

3. There was a significant increase in oil prices in 1979 - 80 following the Iranian Revolution. What are the implications of this negative supply shock on labor markets?

Answer 1

(2)

Demand for labor is given by Value of marginal product of labor (VMPL), where

VMPL = Marginal product of labor (MPL) x Wage rate

Therefore, when MPL falls, VMPL falls and labor demand decreases. The labor demand curve shifts leftward, decreasing wage rate and decreasing quantity of labor.

In following graph, wage rate (P) and quantity of labor (Q) are measured vertically and horizontally respectively. D0 and S0 are initial demand and supply curves of labor intersecting at point A with initial wage rate P0 and quantity of labor Q0. As labor demand falls, D0 shifts left to D1, intersecting S0 at point B with lower wage rate P1 and lower quantity of labor Q1. There is an unemployment equal to (Q0 - Q1).

NOTE: As per Answering Policy, 1st question is answered.