Question

Suppose labor demand and supply are represented by the equations Demand: LD = 100 − 2W, Supply: LS = 2W. a. Find the equilibrium wage and employment level. b. Explain why $30 cannot be the market clearing wage. c. Suppose 5 workers are hired at a wage of $30. Show an example where an exchange can occur that is beneficial to multiple people. How much economic rent is generated by this transaction? d. If workers earn economic rent, does that mean they are being overpaid? e. Suppose all hiring in this market must be done through a union and the union has limited the supply of labor to 40 units. What wage will emerge in this market? How much economic rent have the employed members of the union gained? How much economic rent has been lost due to the limitation on union labor?

Answer 1

Answer:

Labor Demand and Supply

a) Equilibrium Wages = $25 and Equilibrium employment level = 2

b) $30 cannot be the market clearing wage.  At $30 labor supply will outstrip labor demand.  In that situation, there is no equilibrium of labor supply and demand.

c) If 5 workers are hired at a wage of $30, the wage bill will be equal to $150 ($30 * 5) and the 5 workers will be receiving an economic rent of $5 each ($30 - 25).  The total economic rent is $25 ($5 * 5).

d) If workers earn economic rent, it does not mean that they are being overpaid.  It simply means that they are being paid above the equilibrium wage.

e) The total wage will be $1,200($30 * 40).  The total economic rent gained by the employed union members is $200 ($5 * 40).  The economic rent lost by limitation on union labor cannot be quantified with the given information.

Explanation:

a) Data and Calculations:

Demand: LD = 100 − 2W

Supply: LS = 2W

Equilibrium wage and employment level exist where Demand = Supply

i.e. LD = LS = 100 - 2W = 2W

Therefore 2W = 100 - 2W

= 4W = 100

= W = 100/4

= W = 25

Equilibrium Wages = $25

Equilibrium employment level = 2

b) Economic rent is the additional or extra income which a resource earns or generates over the normal earnings as a result of being put to use in its present form.  This means that the extra income could be lost without jeopardizing the deployment of the resource to some productive use.