Question

Choose the most appropriate answer. Write down the question number and the correct letter next to it. E.g. 1.11 A

In an industry, if wages increase more than the productivity of workers, we would expect:

(a) an upward pressure on prices.
(b) a decrease in unemployment. investment in the industry to increase. costs of production to fall.
the demand for labour to rise

(c) investment in the industry to increase. costs of production to fall.
the demand for labour to rise.

(d) costs of production to fall.

(e) the demand for labour to rise.

Answer 1

Answer: In an industry, if wages increase more than the productivity of workers, we would expect (a) an upward pressure on prices. This is due to the optimality condition of the firms. The firms choose the factor inputs such that they are optimal at the margin. In other words, the input level is one where the marginal benefit from employing an extra unit of input equals the marginal cost of hiring that input. When wages increase more than the productivity of workers, the marginal cost is rising by more than the marginal benefit.This implies, the cost of production increases and the demand for labor falls. As a result, employment will fall and the production by the firm will decrease. This will lead to a decrease in the supply of the good in the market, and therefore an upward pressure on prices.

[Reasons for why other options are incorrect are subsumed in the statement above.]