When the cost of these other factors goes up firms purchase less of them This

When the cost of these other factors goes up firms

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When the cost of these other factors goes up, firms purchase less of them. This usually decreases the marginal product of labor, shifting the labor demand curve to the left. When the cost of these other factors goes down, firms purchase more of them, shifting the labor demand curve to the right. A change in the credit market equilibrium can also influence labor demand by affecting the firm’s cost of financing the acquisition of physical capital.
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Panel (a) is flexible wages while Panel (c) is the case for rigid wages The labor market equilibrium corresponds to the wage and employment levels given by the intersection of the labor supply and demand curves Employment fluctuations corresponding to changes in the labor market equilibrium are linked to fluctuations in real GDP (panel c) Panel (a) illustrates a leftward shift in the labor demand curve, which reduces the
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equilibrium quantity of labor employed Before a recession, the original equilibrium is given by the point ‘1. Pre- recession’ with the equilibrium wage at the point labeled ‘Pre-recession wage’ on the vertical axis, and equilibrium quantity of labor demanded at the point labeled ‘Pre-recession employment’ on the horizontal axis. Following an economic shock that leads to a recession, the labor demand curve (blue-line) shifts to the left, reaching a new equilibrium at the point labeled “2: Recession’. This new equilibrium features a lower wage and a lower quantity of labor demanded. Panel (b) illustrates the aggregate production function. Holding physical capital and technology constant, this curve shows the relationship between employment and real GDP. As employment declines, so does real GDP (because there is less labor producing goods and services). Accordingly, employment and real GDP rises and fall together. The fall in real GDP might exceed what is shown in Panel (b) because the decline in employment generates other types of economic adjustment. Laying off workers makes physical capital that the workers use - plant and machinery - less productive, leading firms to shutter some of their plants and machinery. The rate of utilization of physical capital is called capacity utilization , and recessions are usually accompanied by a reduction in capacity utilization. In reality, wages are downward rigid - meaning that they do not adjust downwards. Thus an the impact of a shift in labor demand is amplified as per Panel (c)
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Firms are then unable or unwilling to to cut wages because of contractual restrictions, morale problems, policy, etc. As a result, firms end up laying off more workers than they would have if wages were downward flexible. With downward rigid wages, a leftward shift in the labor demand curve causes unemployment to fall by even more than it does in the flexible wage case.
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