Question

5. An economy with 1,000 machines and 125 workers has a production function Y = 3K1=3L 2=3 . What would be the unemployment rate if the government determines a minimum real wage of: (a) 2 units of output? (b) 4.5 units of output? [Hint: You may start by determining the equilibrium real wage without the minimum wage constraint. Then, you should check whether the constraint is binding, i.e., whether the equilibrium real wage is less than the legal minimum. If that is the case, there will be unemployment and the number of unemployed would equal the supply of labor less the demand of labor at the minimum real wage.]

Answer 1

In the figure above X axis shows the labour unit and Y axis the real wage rate.LS represents the supply of labour,LD represents demand for labour,equilribrium is attained at the point E G and H when the supply of labour is equal to the demand of labour the market is in equilibrium but minimum wage imposed by the government changes the situation.Minimum wage is set above the market wage ie 4.5 units of real wage is much above the market wage.It shows that the unemployment increases due to the minimum wage