The theory behind deregulating various product markets like air travel, trucking and so on was to break down monopoly power, do away with regulation that was generally ineffective, and make the markets more competitive. Holding all else constant, when monopoly power is broken down, an industry should be able to produce more output at a lower price.
Consider a firm with a production function given by the equation
In short run suppose the level of capital is fixed at 16 units. The marginal product of labor in the short run is given by the equation
Suppose initially that a firm has been granted monopoly power by the government and faces a demand curve given by P=20-.5Q and the marginal revenue is given by MR=20-Q. The firm faces competition in the labor market where the going price of labor is $10. Suppose that regulation is ineffective and the firm acts as a normal profit maximizing monopolist.
a. Find out the equation for the firm's labor demand curve. Find the optimal level of labor for the firm to demand.
b. Using your answers to part (a), how much output will the firm produce and what price will it charge?
c. Now suppose the market in which the firm sells its product is deregulated and new competitors enter the market. Suppose the price of the product falls to $15. Find the firm's demand curve for labor under competition. Using the new demand curve equation, find the optimal level of labor for the firm to demand. How much output will the firm produce now?
d. On the same graph, plot the demand curves and quantity demanded before and after regulation.
e. Based on your graph, what effect did deregulation have on labor demand?