Final answer:
A reduction in productivity causes the labor demand curve to shift to the left, leading to a decrease in the quantity of labor demanded at existing wage rates and an increase in cyclical unemployment.
Step-by-step explanation:
When a country experiences a reduction in productivity, also known as an adverse shock to the production function, the labor demand curve in the labor market is affected. In such a scenario, firms will perceive a less productive economy, which may mirror the onset of a recession.
As a result, firms will wish to hire a lower quantity of labor at any given wage, leading to a leftward shift in the labor demand curve.
This shift reflects a decrease in the number of workers firms are willing to employ at the previous equilibrium wage rates. An example of this can be seen in Figure 8.7 (b), where the labor demand curve moves from D0 to D1.
Wages tend to be sticky downward, meaning they do not quickly adjust to a lower equilibrium wage, W1, in the short run. Consequently, there is a gap between the quantity of labor firms are willing to hire at the existing wages (Q2) and the quantity of workers willing to work (Q0), representing an increase in cyclical unemployment.
Moreover, the gap between Q0 and Q2 signifies the economic impact of a recession, where workers are willing to work but cannot find jobs due to decreased demand for labor. Such adverse shocks to the labor market also have implications on aggregate supply, with both the short-run aggregate supply (SRAS) and long-run aggregate supply (LRAS) potentially shifting to the left, indicating a reduction in overall production capacity.