In the labor market diagram below, labor demand shifts left from LD to LD′. The initial equilibrium is point A.

Question

BlackTom AI · Accepted Answer

First, I will restate the problem setup and the two blanks to be filled: In the labor market diagram, the labor demand shifts left from LD to LD’. The initial equilibrium is point A. The two blanks to complete are: 1) which point (A, B, or C) corresponds to actual employment immediately after the shock if wages are rigid? 2) what kind of unemployment is represented by the horizontal gap between points A and C?

Now, evaluating each candidate for the first blank:
- Point A: This is the pre-shock equilibrium where the original LD and LS intersect. If wages are rigid, the economy cannot move to the new equilibrium defined by LD’ and LS at the same wage, so employment would not stay at A after the shock. Therefore A does not represent the immediate post-shock outcome with sticky wages.
- Point B: This point lies at a lower quantity of employment than A but at a wage level that does not align with the new demand curve LD’. If wages are rigid, the market cannot clear at the new demand; B would imply a different wage or a different interpretation of the supply/demand intersection than is appropriate for a wage-stickiness scenario. Hence B is not the correct immediate post-shock employment under wage rigidity.
- Point C: This point is positioned at the wage level that remains fixed (the rigid wage) and lies where the fixed wage line intersects the new downward-sloping demand LD’. This intersection yields the quantity of labor actually employed when wages do not adjust downward to clear the market after the demand shift. In other words, C captures the real-world consequence of a demand shock when wages are sticky: employment falls to the level where the fixed wage intersects the new demand, not to the new market-clearing level. Therefore C correctly represents the actual employment immediately after the shock with wage rigidity.

Evaluating the second blank:
- The horizontal gap between A (the original equilibrium at the initial wage) and C (the post-shock employment at the fixed wage) represents unemployment that arises because the wage cannot adjust to clear the market after the demand shift. This is textbook cyclical unemployment: a temporary shortfall in aggregate demand (or in this micro-lable, labor demand) relative to the number of workers willing to work at the fixed wage. The gap is horizontal because the wage is fixed; workers who want to work at that wage cannot find jobs because firms reduce hiring due to the lower demand, not because of a change in prices or a mismatch in skills.

Putting it together, the selected responses are: C for the first blank, and cyclical unemployment for the second blank. This aligns with the standard interpretation of a downward shift in labor demand under wage rigidity producing a lower employment level and a horizontal unemployment gap attributable to cyclical unemployment.

ECON_002_001_25F Problem Set 3

In the labor market diagram below, labor demand shifts left from LD to LD′. The initial equilibrium is point A.

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