Imagine a firm trying to minimize its unit labour cost and a situation where the employee actually responds to higher wages by putting more effort on the job. Moreover, the reservation wage of the employee (the minimum wage at which they are willing to work) is 15 dollars per hour. In fact, imagine the following relationship between output and the wage rate:
wage per hour Output per hour
15 170
16 190
17 208
18 224
19 238
20 250
21 260
22 268
23 274
24 278
25 280
a) Should the firm pay its employee as little as possible in an attempt to make the most money? If not, what do you think would be the best choice for the firm in terms of wage level? Show your work (and feel free to provide a graph if you want).
b) Suppose the reservation wage increases to 17 dollars. How would this likely affect the situation and your analysis in a) (would the answer change? If so, how?).
According to the neo-classical theory of wage setting, discrimination should be gradually weeded out of the labour market. Explain why this should be the case according to that theory. Discrimination, however, seems to endure. What is a plausible explanation for this state of affairs?