i) Use the following diagram of the classical labor market to answer the questions.
a) Suppose the wage rate is at $4. What situation is present? 3 marks
When the wage rate is at $4, the supply of labor is 900. As the demand of labor market is 1200. There is a shortage of the labor and wage rate.
b) What is the equilibrium level in wage rate and labor? 4 marks
The equilibrium level in wage rate will be $5 and the labor will be 1000 units. As on this point, the quantity demanded equals quantity supplied and the market price has no tendency to change,
c) Describe it with the diagram, if workers increase the value that they place on nonmarket activities (e.g. leisure), what would happen for the equilibrium to the labor market? 6 marks
If workers increase the value on nonmarket activities, they place a lower value on their time to spend in nonmarket activities. It reduces the productivity. As decrease in the units of labor, it causes the supply shift to left which leads to the increasing of wage rate. The equilibrium will be around $5.3 for wage rate and around 940 units of labor.
ii) The price of oil fell sharply in1986 and again in 1998. Show the impact of such a change in both the aggregate-demand/ aggregated supply diagram and in the Phillips curve diagram. What happens to inflation and unemployment in the short run? 12 marks
The price of oil decrease increase the money supply (MS). Increasing MS lower the interest rate which increase the investment. Causing the aggregate demand (AD) curve shift to right form AD0 to AD1 then increase in output at each possible price level.
On the other hands, the price of oil fell then decreasing the costs of production and the expected future cost. The aggregate supply curve shifts to the right causing the decrease of the oil price level and increase in the quantity of output (income).
As the price level decline, the Phillips curve shift to left based on inflationary expectations decline. It leads to less inflation at the level of unemployment rate.