Question

Consider a firm’s initial optimal employment level in the short run. Suddenly a positive technology shock occurs such that EVERY employee is now able to produce an additional 15 units of output above what they were originally able to produce. What happens to employment at this firm:

• Do employment levels increase, decrease, or stay the same?

• EXPLAIN YOUR ANSWER. NO POINTS will be given if you do not EXPLAIN your choice.

Answer 1

An additional increase in production by 15 units of output per employee due to positive technology shock indicate an increase in marginal physical product of employee by 15 units of output.

The demand for labor = Value of Marginal Product of the Labor = Marginal Revenue Product of Labor = Marginal Physical Product of the Labor * Price of the Product

VMPL = MRPL = MPPL * P

Thus, an increase in MPPL indicate increase in VMPL, implying rightward shift in the demand for labor curve.

When the supply of labor is upward sloping in the short-run, an increase in demand for labor would lead to increase in employment along with the wages.

When supply of the labor curve is horizontal, an increase in demand for labor would lead to increase in employment at a constant wage

On the other hand, when supply of the labor curve is vertical straight line, indicating a fixed supply of labor, an increase in demand for labor would not lead to increase in employment level. However, wage rate would increase proportionate to the increase in the demand for labpr.