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    marginal productivity theory of labor demand

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    1. Use the marginal productivity theory of labor demand to predict the impact on the firm's employment level of the following events. Explain why the change in employment occurs and show it in a graph.

    a) A decrease in the wage rate.
    b) An increase in the demand for the firm's product
    c) A lower tariff on imported goods
    d) The conversion of the firm from a perfectly competitive firm to a monopolistically competitive firm

    2. State whether items a - d are true, false, or uncertain, and briefly explain why.

    a) Diminishing marginal productivity of labor begins when the total product curve reaches a peak and then declines
    b) If the labor demand curve is inelastic, lowering the wage rate will result in a decrease in the firm's wage bill
    c) Since skilled workers are paid a higher wage than the less skilled, the firm has an incentive to lay off the skilled workers first during a recession
    d) Whether or not a college student had been elected to office in the student government is a useful screening device for employers.

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    Solution Preview

    Please see attached file.

    (1) Use the marginal productivity theory of labor demand to predict the impact on the firm's employment level of the following events. Explain why the change in employment occurs and show it in a graph.

    a) A decrease in the wage rate.

    A decrease in the wage rate from W1 to W2 will cause an increase in employment from L1 to L2. This is shown in Figure 4.1, (a) as a movement down the demand curve from point X to Y. According to the marginal productivity theory, a firm should hire workers up to the point the wage equals the MRPL of the last worker. At W1 the demand curve shows this to be the L1st worker. At a lower wage of W2, however, it pays to expand employment to L2, since all workers between L1 and L2 now have a MRPL larger than the wage.

    b) An increase in the demand for the firm's product

    An increase in product demand will lead to an increase in employment. In graph (b), at the existing level of production the firm hires L1 workers (point X) at the wage W1. An increase in product demand shifts the labor demand curve to the right from D1 to D2, and at the wage W1 employment rises from L1 to L2 (point X to Y). The reason is that ...

    Solution Summary

    The marginal productivity theory of labor demand is examined.

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