Question

Explain, using the concepts of scale and substitution effects, the effects of an increase in low productivity worker wages on the employment of high productivity workers.

Answer 1

According to neoclassical theory if the wage rate is increased for low productivity workers, then there will be unemployment. This will happen because off the scale effect where companies have to increase the price of their products when they have to pay a higher wage. This will discourage consumers from buying their goods and hence reduce their demand.

Secondly lower productivity workers are expensive when their wages are increased so firms might decide to replace them with machines or with a high productivity workers and this substitution is known as substitution effect. Therefore when there is an increase in the wages of low productivity workers there will be an increased employment of high productivity workers.