Question

True or False.

An increase of total factor productivity only shifts the labor demand curve to the right.

I know that answer is false because it shifts the labor supply curve also but I need help understanding why.

Answer 1

False.

• An increase of total factor productivity shifts both the labour demand curve and the labour supply curve.
• The total factor productivity refers to the growth in the total output in an economy which is driven by the weighted average of inputs like labour and capital.
• When the total factor productivity increases, the marginal product of labour increases which shifts the labour demand curve to the right.
• This is because, when the production increases, the consumption also increases which increases the demand for goods. As a result the demand curve shifts to the right.
• We know that an increase in the total factor productivity increases the real interest rate, aggregate output and also the employment.
• The increase in employment and the increase in demand leads to an increase in the labour supply too, which shifts the labour supply curve to the right.