Final answer:
A reduction in the productivity parameter A causes the labor demand curve to shift leftward, indicating that firms are willing to employ less labor at each wage rate due to decreased productivity. This results in a lower equilibrium wage and higher unemployment, given a constant supply of labor.
Step-by-step explanation:
When a country experiences a reduction in the productivity parameter A, there is a shift in the labor demand curve. In a production function Y = AKαL1-α, a decrease in A represents a fall in overall productivity. This, in turn, leads to a leftward shift in the labor demand curve. Why? Because each worker is now less productive, firms are willing to pay less for labor, or they need less labor to produce the same amount of output.
Graphically, you would draw a downward-sloping labor demand curve in a graph with wages on the vertical axis and quantity of labor on the horizontal axis. The initial demand curve (D0) would shift to the left to become D1 after the productivity decline. This shift illustrates a decrease in the quantity of labor demanded at any given wage rate, due to a drop in the marginal product of labor. The intersection point with the labor supply curve moves to the left, resulting in a lower equilibrium wage and a reduction in the quantity of labor employed, assuming the labor supply remains constant. This reflects greater unemployment or underemployment in the economy.
In contrast, if there were an increase in productivity, as witnessed in the late 1990s, it would shift the labor demand curve to the right, as firms would require more labor to capitalize on the increased productivity, given the production function. However, in our scenario with decreased productivity, it is the opposite. Higher prices for other inputs, analogous to the reduced productivity in our scenario, would similarly lead to a downward or leftward shift in the labor demand curve, as seen in the provided references.