1. C.
Wage
Explanation: Wage is the price paid for labor in the labor market.
2. C. Workers
Explanation: In the labor market, individuals (workers) supply their labor in exchange
for wages.
3. C. Increases
Explanation: According to the law of supply, higher wages incentivize more people to
supply labor.
4. B. Hire workers until wage equals marginal revenue product
Explanation: Firms maximize profit by hiring workers up to the point where the cost
of hiring one more worker (wage) equals the revenue generated by that worker.
5. B. Extra revenue from one more unit of labor
Explanation: MRP measures the additional revenue earned from employing one more
unit of labor.
6. C. Labor demand decreases
Explanation: If capital becomes cheaper and can replace labor, businesses may reduce
labor demand due to substitution.
7. C. It increases
Explanation: Improved productivity means each worker contributes more, increasing
their value and thus labor demand.
8. C. Decrease in labor demand
Explanation: Higher nonwage costs (like taxes or benefits) make hiring more
expensive, discouraging demand for labor.
9. B. Demand for a worker due to demand for the product they produce
Explanation: Labor demand is “derived” from the demand for goods/services that
labor helps produce.
10. B. Upward-sloping
Explanation: The substitution effect encourages more work when wages rise, making
the labor supply curve slope upward.
11. B. Work until wage equals marginal benefit of leisure
Explanation: Workers balance time between labor and leisure, working more only if
wage compensates for lost leisure.
12. B. An hour of leisure
Explanation: The cost of working more is the leisure time you give up.
13. C. Rise in benefits of not working
Explanation: If the benefits of staying out of the workforce rise (like generous
welfare), labor supply decreases.
14. B. Income and substitution effects cancel each other out
Explanation: A vertical labor supply curve shows no change in hours worked as
wages change, meaning effects offset.
15. C. Improved worker productivity
Explanation: Higher productivity increases the marginal revenue product, shifting
labor demand right.
16. C. Income effect dominates at high wages
Explanation: At high wages, workers may choose more leisure over work, bending
the supply curve backward.
17. C. Labor supply decreases
Explanation: Restricting immigration reduces the number of potential workers,
decreasing labor supply.
18. C. Decrease
Explanation: If alternative jobs pay more, fewer workers will stay in the current job
market, reducing supply.
19. B. Upward
Explanation: Higher wages typically attract more people into the labor force,
increasing quantity supplied.
20. C. Determine which curve is shifting
Explanation: The first step in analyzing changes is to identify whether supply or
demand is shifting.
Short Questions
1. Explain the Rational Rule for Employers and how it helps firms decide the number of
workers to hire.
Answer Key:
The Rational Rule for Employers states that a firm should hire additional workers as long as
the marginal revenue product (MRP) of labor is greater than or equal to the wage paid
to the worker. The MRP is the additional revenue generated by hiring one more worker.
This rule helps firms determine the optimal number of workers to hire by comparing the
marginal benefit (revenue from extra output) and marginal cost (wage). Employers
continue hiring until the wage = MRP, thereby maximizing profits and avoiding the cost of
hiring workers who do not add sufficient value.
2. Differentiate between the substitution effect and the income effect in relation to labor
supply.
Answer Key:
Substitution Effect: When wages rise, the opportunity cost of leisure increases.
Leisure becomes more expensive because a worker gives up more income by not
working. This encourages individuals to substitute leisure for labor, resulting in
more hours worked. This causes the labor supply curve to slope upward.
Income Effect: As wages rise, individuals earn more income for the same number of
hours. This may lead them to consume more leisure (a normal good) and work
fewer hours. This causes the labor supply curve to slope downward.
The overall shape of the labor supply curve depends on which effect dominates.
3. How do changes in the price of capital affect labor demand when labor and capital
are substitutes versus complements?
Answer Key:
When labor and capital are substitutes:
A decrease in the price of capital (e.g., cheaper machines) leads firms to replace
workers with machines, thereby reducing labor demand. This results in a leftward
shift of the labor demand curve.
When labor and capital are complements:
A decrease in the price of capital enables firms to expand production, which may
require more workers to operate or complement the use of new capital. This leads to
an increase in labor demand, shown by a rightward shift in the labor demand
curve.
Whether labor demand increases or decreases depends on whether the substitution effect or
the scale effect dominates.
4. List and briefly explain any four factors that shift the labor supply curve.
Answer Key:
1. Changing Wages in Other Occupations:
If wages increase in alternative jobs, workers may switch occupations, reducing labor
supply in the current job.
2. Changes in the Number of Potential Workers:
Population growth, immigration, and demographic changes (e.g., more people in
working-age brackets) can increase or decrease labor supply.
3. Changing Benefits of Not Working:
More generous welfare, unemployment benefits, or student subsidies can reduce the
incentive to work, lowering labor supply.
4. Nonwage Benefits, Subsidies, and Taxes:
Improved employment benefits or lower income taxes make work more attractive,
increasing labor supply; the reverse reduces it.
5. Describe what is meant by “derived demand” in the context of labor markets.
Answer Key:
Derived demand refers to the concept that the demand for labor is not independent but is
derived from the demand for the goods and services that labor helps produce. For
example, if there is increased demand for haircuts, the demand for hair stylists will also
increase. Employers only hire workers when there is a demand for the output those workers
produce.