The labour market equilibrium is now achieved at a

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The labour market equilibrium is now achieved at a new level of nominal wage W1 and employment (N1). This leads to a decline of output level due to the decrease in labour productivity, from Y0 to Y1. The vertical aggregate supply curve shifts to the left. The increase in the nominal wage ( W 0 ¿ W 1 ¿ outweighs the increase in the price ( P o ¿ P 1 ¿ . Therefore, the net effect on the real wage will be increasing. In short, increasing marginal income tax rate affects the output level. FIGURE 5.1 A There are sometimes special case of full employment happening in real world. In this context, we would still be focusing on the marginal tax rate as discussed from the diagram previously. When employment has reached its full capacity, a cut in marginal tax rate shall impose effect on labour productivity instead of labour supply curve. A cut in the marginal tax rate will increase the disposable income available to every household. Suppose an increase in income will increase the labour supply, but at full employment where no excess or extra
labour will be demanded, labour productivity will be increasing. Labour who gain more income will be willing to work more efficiently thus increasing the whole labour productivity. The figure above illustrates the effect of increasing in labour productivity. Initially, equilibrium in labor market achieve when ND 0 = NS 0 at point E 0 with real wage of w 0 p and price level at P 0. Employment will be at N 0 and produce output at Y 0 . An equilibrium is achieved with price = P 0 and output = Y 0. When there is increase in labour productivity, production function shift from Y 0 = f ( ´ K ,N ¿ to Y 1 = f ( ´ K ,N ¿ . Labor demand increase shift ND curve from ND 0 to ND 1 (because of W P =MPN). New labor equilibrium achieves at NS 0 =ND 1 at point E 1 . Real wage increases from w 0 p to w 1 p as the willingness for the worker to work increase. Employment rate increase from N 0 to N 1 . Aggregate supply increase shift AS curve from AS 0 to AS 1 . The price drop from P 0 to P 1 . Output increase from Y 0 to Y 1. In short, increasing marginal income tax rate affects the output level. FIGURE 5.1 B This is the same source of financing which to increase the marginal income tax rate, but having the nominal wage instead of real wage in the labour market equilibrium. The figure above illustrates the effect of increasing in labour productivity. Initially, equilibrium in labor market achieve when ND 0 = NS 0 at point E 0 with nominal wage of W 0 and price level at P 0. Employment will be at N 0 and produce output at Y 0 . An equilibrium is achieved with price = P 0 and output = Y 0.
When there is increase in labour productivity, production function shift from Y 0 = f ( ´ K ,N ¿ to Y 1 = f ( ´ K ,N ¿ . Labor demand increase shift ND curve from Nd0 (P0 x MPN) to Nd1 (P1 x MPN) (because of W=MPN×P). New labor equilibrium achieves at NS 0 =ND 1 (P1 x MPN) at point E 1 . Nominal wage increases from W 0 to W 1 as the willingness for the worker to work increase. Employment rate increase from N 0 to N 1 .

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