Question

Consider two labour markets — one for high-skilled workers and one for low-skilled workers. Each market is initially in equilibrium. The high level of skill is acquired through costly education

If the cost of education were to increase, explain the process by which the markets would adjust to a new equilibrium.

Answer 1

High skilled and low skilled labor are considered weak substitutes in production process.

If cost of acquiring high level of skills becomes costly, the prospective workers would reduce in numbers (as cost of acquiring skills increases). As a result, supply of high skilled workers falls and shifts to the left.

As a result, wage rate of high skilled workers increases while their employment falls.

Firms will now start looking for cheaper substitutes to these workers and thus resort to the low skilled workers for employment. As a result, demand for low skilled workers will increase, shifting demand curve to the right.

Keeping supply curve unchanged, this will lead to an increase in both wages and employment level of low skilled workers.

As a result, new equilibrium occurs in both the markets at high wage rates.