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    Supply and Demand

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    In 1996 Congress raised the minimum wage from $4.25 to $5.15 per hour. Some people suggested that a government subsidy could help employers finance the higher wage. This exercise examines the economics of a minimum wage and wage subsidies IN A MAKE-BELIEVE COUNTRY.
    Suppose the supply of low skilled labor is given by LABOR SUPPLY = 10*w millions where w is the wage rate [in dollars per hour]. The demand for labor is given by LABOR DEMAND = 80 - 10*w millions.

    a) What will be the free market wage rate and employment level?

    b)Suppose the government sets a $5.00 per hour minimum wage. What will be the employment level?

    c) Suppose the government pays a subsidy of $1 per hour directly to the employee. What will be the market wage and employment level? How much will the government pay per week [suppose every laborer works 40 hours]?

    NOTE that the three possible actions a, b, and c are independent of each other - the answer to any one does not depend on any other.

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    Solution Preview

    Answer (a):
    Free Market wage rate is when LABOR SUPPLY = LABOR DEMAND
    Thus 10w = 80 - 10w
    => 20w = 80
    => w = 4

    Thus a free market wage rate is $4 per hour. At this rate, the labor supply is 10x4 = 40 million

    Answer (b):
    If the government sets a $5 per hour minimum ...

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