Problem set topic 2 Essay Example

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Problem set topic 2

Question 1.

The reason why demand for labour of a firm in a perfectly competitive industry slope downwards in the short-run is as a result of the law of diminishing returns. With increase in the number of workers hired, Marginal product of labour begins to decline which in turn causes marginal revenue product of labour to fall as well. Intersection of marginal revenue product curve with the market wage determines the number of workers that the firm hires.

Question 2.

The substitution and scale effects of a wage increase when inputs are:

    1. perfectly substitutable

The firm rearranges the mix of inputs by reducing the number of workers and substituting the number of works with units of the other cheap available inputs like capital

The firm reduces its production capacity of labour by reducing the number of labours as a result of high wage rate.

    1. imperfect substitutes,

The firm will not rearrange the mix of inputs. The firm will be compelled to continue employing same units of labour if at the high wage rate.

The production capacity of labour will still be the same since there will be substitution.

    1. Complements

The firm will rearrange the mix of inputs by reducing the inputs used proportionately.

The production capacity of the firm will reduce since the units of inputs will be reduced.

Technology which will lead to a high wage elasticity of labour demand in the L-R is the one which uses perfect substitutes in production process.

Question 3.

  1. S-workers

Cost $40/hr, 80 units/hr


Cost of producing one unit is $ 0.5

U workers

Cost $4/hr, 6units/hr

Cost of producing one unit is $0.67

The firm should hire skilled workers since the cost of producing one unit using this type of workers is lower compared to the case of unskilled workers

  1. If Q* is 960 units/hr, the net gain of using the right type of workers will be;





The net gain of using the right type of workers will be;

$(240-24)/unit= $216/unit

Question 4.

Outlining the possible effects on the demand for youth labour of a substantial fall in the average wage rate for youth labour and the likely effects on the demand for other unskilled workers:

With a substantial fall in the average wage rate for the youth, there will be an increase the demand of youth workforce by the firms since it the cost of labour will be low. The already skilled youth in the labour market withdraw their services since the compensation for the services they offer is low.

The unskilled workers end up being absorbed since those who are skilled do not find it being profitable to offer labour services the low prevailing wage rate.