ELS Chapter 6: Graphing Exercise Answers
Using the labor market to understand employment and wage trends
1. Before working with the applet, think about how an increase in productivity will affect the demand for and supply of labor in the labor market. Will a change in productivity affect labor demand? Will it affect labor supply? In what way? Why?
  Answer: A change in productivity allows current workers to produce more output each hour, which in turn generates more revenue, and hence profit, for the firm when it is sold. The higher profits lead competitive firms to increase production, which in turn increases the demand for workers. Thus, an increase in labor productivity increases labor demand, while leaving the labor supply curve unchanged.
2. What will be the effect of an increase in labor productivity on the level of employment and the real wage in the labor market? What happens to the real wage? What happens to the level of employment? Why?
  Answer: An increase in labor productivity increases the demand for labor, shifting it to the right. The shift in labor demand creates an excess demand (shortage) for labor at the current real wage rate, so the real wage will be "bid up" by employers trying to fill jobs. As the real wage rate rises, the quantity of labor supplied (along the curve) increases, while the quantity of labor demanded (along the curve) falls, and the excess demand gets smaller. When the real wage rises enough to eliminate the excess demand the market is in equilibrium. Both the real wage and employment at the new equilibrium are higher than at the original equilibrium.
3. According to the labor market model, what types of shifts in labor demand or labor supply can explain the long-term increase in real wages? What do these shifts imply about employment trends? Which shifts are plausible and which are not? Why?
  Answer: Real wages rise in response to a shortage of labor, which can occur either because labor demand increases or labor supply falls. A decline in labor supply is not plausible, as this suggests that overall employment is falling, rather than rising. Actual employment has grown dramatically over time. What about an increase in labor demand? Increases in labor demand are primarily the result of increases in labor productivity, which has increased in the long run. Increases in labor demand also lead to an increase in employment. Thus, because the underlying causes of increases in labor demand (higher labor productivity) are consistent with observed behavior, as well as the result of increases in labor demand (higher employment), increases in labor demand are a plausible explanation for the observed behavior of wages and employment over time.

4.

 What will be the effect of an increase in immigration on the level of employment and the real wage in the labor market? What happens to the real wage and level of employment at the new equilibrium? Why?

Based on your analysis, do you conclude that increasing the level of immigration into the U.S. would be beneficial or harmful for the U.S.? Explain, using economic arguments to frame your answer.
  Answer: The increase in labor supply causes an excess supply of labor (surplus) at the original real wage rate. Some suppliers of labor will begin to offer their services for lower wages rather than go without a job; thus, the real wage in the market will begin to fall. As the real wage rate falls, the quantity of labor demanded (along the curve) increases, while the quantity of labor supplied (along the curve) falls, and the excess supply gets smaller. When the real wage falls enough to eliminate the excess supply the market is in equilibrium. The real wage falls, while the level of employment is larger at the new equilibrium than at the original equilibrium.

As in many cases in economics, there is no single clear-cut answer to this question. The analysis above suggests that an increase in immigration rates will reduce real wages overall in the U.S. In addition, some current U.S. workers may lose jobs due to increased competition for available jobs, but overall the increase in immigration leads to higher employment in the U.S. labor market (and higher levels of output in the U.S. economy). The lower wages and higher output resulting from the increase in immigration would (as you will find out in later chapters) also help to keep the rate of inflation down in the U.S.