The diagram below shows a perfectly competitive labour market. The initial equilibrium is with wage \(w^{*}\) and employment \(L^{*}\).

a. Suppose the demand for labour decreases to \(D_{\mathrm{L}}^{\prime}\). If wages are perfectly flexible, what is the effect on wages and employment? Show this in the diagram.

b. Is there any involuntary unemployment in part

(a) after the shock?

c. Now suppose wages can only adjust half as much as in part (a)-that is, wages are sticky. What is the effect on wages and employment in this case? Show this in the diagram.

d. Is there any involuntary unemployment in part

(c) after the shock? How much?

Transcribed Image Text:

Real Wage W* 0 L* Employment D D S