Aggregate Demand Externalities and Labor Supply Decisions: Worker Discouragement and Market Inefficiency

Arindrajit Dube and Ethan Kaplan, Economics Letters 56(1), 89-94, September .


When monopolistic firnls price using markups over worker productivity, low productivity workers may not enter the labor market because the wage may be too low. In the presence of aggregate demand spillovers, a profits tax used to subsidize discouraged workers (an earned income tax credit) can actually be Pareto improving and raise profits. 

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