Question

Suppose government imposes a 50% tax on the wages “high productivity” firms pay to their employees but not on the wages “low productivity” firms pay to theirs. The tax lowers the profit of “high productivity” firms at each number of workers employed to Profit(L) = q(L) – (1 +50%)wL.

There are 20 firms in a perfectly competitive industry. Ten firms have production function q = 2L^0.5 while the other ten firms have production function q = 4L^0.5. We label the first type of firms, “low productivity” and the second type of firms, “high productivity.” All firms sell their output at a unit price of P = $1. All firms are price takers in the labor market.

1) How does this tax affect the net wage w paid to workers?

2) How does it affect the allocation of workers between types of firms?

3) What are the total output consequences of this tax?

4) Suppose government imposed the 50% tax on wages on firms with “low productivity” as well. Would efficiency increase or decrease? Justify your answer.

Answer 1