COVID-19 measures in the labor market : The COVID-19 pandemic has had large effects on the economy

5. COVID-19 measures in the labor market (25 %)

The COVID-19 pandemic has had large effects on the economy. There have been particularly large effects on industries that rely on the physical presence of their customers, such as airlines, cinemas, cafes, and hotels. Politicians and economists alike are debating how to best tackle these issues. In this question we will attempt to compare the costs of two different policies aimed at the labor market. We assume that the market for labor is perfectly competitive and that it was in equilibrium before the pandemic.

(a) In a supply-demand diagram of the labor market, illustrate the shift in demand for labor from firms. Notice that the price of labor (the wage) in Norway has not changed, due to employment protection laws. What is the implication of this? Explain. The first response of the Norwegian government was to make it easier for firms to put employees on unpaid temporary layoff. Then, the government had to pay unemployment benefits to these individuals. One way to analyze this strategy, is to think of unemployment benefits as a form of price support, where the government purchases the excess supply in the labor market. For simplicity, assume the government pays the original wage as unemployment benefits.

(b) In a graph, show the cost (of unemployment benefits) to the government of that strategy. Explain. Before the summer of 2020, the government introduced a new policy. Specifically, they paid a wage subsidy to firms in struggling industries, so that they may continue employing the workers who otherwise would be laid off. Assume the government pays a subsidy to get back to the pre-pandemic labor market equilibrium. (I.e. the wage is still at the same unchanged level.)

(c) In a graph, show the cost to the government of such a subsidy scheme. Explain.

(d) Compare the cost of the two policies. Are there any other concerns the government should take into account than the these costs?