Labor Economics: Exercise 1

Percentage Grade = (Total number of points / 90) x 100

1. The textbook mentioned that, in the early 1970s, Egypt experienced a dramatic
outflow of construction workers seeking higher wages in Saudi Arabia, at the same
time that the demand for their services rose within Egypt. Graphically represent
these two shifts of supply and demand, and then use the graph to predict the
direction of change in wages and employment within Egypt's construction sector
during that period.
Answer : The graph should show wages on the vertical axis and the
number of workers on the horizontal axis. The outflow of construction
workers should shift the labor supply curve of Egypts construction sector
to the left while the demand curve for the services of Egyptian
construction workers should shift to the right. Both shifts should increase
the equilibrium wage. The two shifts have opposite effects on employment
so the change in employment should be ambiguous.
Graph = 4 points, text = 4 points
2. Analyze the impact of the following changes on wages and employment in a
given occupation:
a. A decrease in the danger of the occupation.
This will make the occupation more attractive shifting the supply
curve to the right, lowering wages and increasing employment in the
occupation. (3 points)
b. An increase in product demand.
This will shift the demand for labor curve to the tight increasing
wages and employment. (3 points)
c. Increased wages in alternative occupations.
This will shift the supply curve of the occupation to the left raising
wages and reducing employment as workers move to the alternative
occupations. (3 points)
d. An increase in the price of machines used in the occupation.
This will shift the demand for labor curve to the tight increasing
wages and employment as firms substitute labor for the relatively more
expensive capital. (3 points)

3. Suppose that the working age population is 210 million, and there are 130 million
who are employed and 5 million who are unemployed. Calculate the unemployment
rate and the labor force participation rate.
Unemployment rate = (unemployed/labor force) x 100 =
(unemployed/employed + unemployed) x 100 = (5 million/ 130 million + 5
million) x100 = (5 million/135 million) x 100 = 3.7% (1 point)
Labor force participation rate = (labor force/working age population) x
100 = (employed + unemployed/working age population) x 100 = (135
million/210 million) x 100 = 64.3% (1 point)
4. Suppose that the supply curve for schoolteachers is LS = 20,000+350W and the
demand curve for schoolteachers is LD = 100,000-150W, where L= the number of
teachers and W= the daily wage.
a. Plot the demand and supply curves.
b. What are the equilibrium wage and employment levels in this market?
c. Now suppose that at any given wage 20,000 more workers are willing to
work as
schoolteachers. Plot the new supply curve and find the new wage and
employment level. Why doesn't employment grow by 20,000?
Answer: a. See the figure. Plot the Ld and Ls curves by solving for
desired employment at given wage rates. If W = 500, for
example, employers desire 25,000 workers (Ld = 100,000
150 500); if W = 400, they would desire 40,000. Since the
equation above is for a straight line, drawing a line using
these two points gives us the demand curve. Use the same
procedure for the labor supply curve. (5 points)

b. To find the equilibrium, solve for the wage at which the

quantity of labor supplied equals the quantity of labor
demanded: Ls = 20,000 + 350W = 100,000 150W = Ld. Solve
for W by adding 150W to both sides and subtracting 20,000
from both sides to yield 500W = 80,000. Dividing both sides
by 500 reveals that W = $160 per day. Plugging W = $160
into both the labor demand and supply equations shows that
L = 76,000 schoolteachers. (2 points)
c. The new labor supply curve is Ls 40,000 + 350W. Setting
this equal to Ld and solving shows that W = $120 per day; L =
82,000 school teachers. Employment doesnt grow by 20,000
because the shift in the supply curve causes the wage to
fall, which induces some teachers to drop out of the market.
(3 points)
5. The marginal revenue product of labor at the local sawmill is MRP L=20-0.5L,
where L= the number of workers. If the wage of sawmill workers is $10 per hour,
then how many workers will the mill hire?
Answer: ThemillwillhireworkersuntilMRPL W.MRPL=20 0.5L 10whenL 20
workers.(1point)
6. The following table shows the number of cakes that could be baked daily at a
local bakery, depending on the number of bakers.
Number of Bakers
0

Number of Cakes
0

1
2
3
4
a.
b.
c.
d.

10
18
23
27
Calculate the MPL.
Do you observe the law of diminishing marginal returns? Explain.
Suppose each cake sells for $10. Calculate the MRP L
Draw the MRPL curve, which is the demand curve for bakers.

Answer: a.
NumberofBakers

NumberofCakes

MPL

MRPL

0
1
2
3
4

0
10
18
23
27

10
8
5
4

100
80
50
40

Themarginalproductoflabor(MPL)iscalculatedinthethirdcolumn,usingthe
followingformula:(5points)
MPL (Numberofcakes)/ L
b. Yes,themarginalproductoflabordeclinesasmorebakersarehired.(1point)
c. Themarginalrevenueproductoflabor(MRPL)iscalculatedinthefourthcolumn,
usingthefollowingformula:(5points)
MRPL MPL P
d. ThedemandforlaboristheMRPLcurve:(3points)

e. Ifeachbakerispaid$80perday,2bakerswouldbehiredand18cakeswouldbe
bakedandsolddaily.(2points)
7. Suppose that the demand for dental hygienists is L D=5000-20W, where L=the
number of dental hygienists and W= the daily wage. What is the own-wage
elasticity of demand for dental hygienists when W= $100 per day? Is the demand
curve elastic or inelastic at this point? What is the own-wage elasticity of demand
when W=$200 per day? Is the demand curve elastic or inelastic at this point?
Answer: Elasticity of demand = % quantity demanded/% wage =
(LD/LD)/(W/W )= (LD/W) x (W/LD) = -20 x (100/3000) = -2/3. The
demand curve is inelastic at this point. (2 points)
8. Suppose that the demand for burger flippers at fast-food restaurants in a small
city is LD=300-20W, where L= the number of burger flippers and W= the wage in
dollars per hour. The equilibrium wage is $4 per hour, but the government puts in
place a minimum wage of $5 per hour.
a. How does the minimum wage affect employment in these fast-food
restaurants? Draw a graph to show what has happened, and estimate the
effects on employment in the fast-food sector.
Answer: The graph should show the downward sloping demand
curve for labor showing equilibrium employment at 220 when the
equilibrium wage equals $4, [300 (20 x 4 ] and employment falling to 200
when a minimum wage equal to $5 is imposed [300 (20 x 4)]. (2 points)
b. Suppose that in the city above, there is an uncovered sector where L S=100+80W and LD=300-20W, before the minimum wage is put in place.

Suppose that all the workers who lose their jobs as burger flippers due to
the introduction of the minimum wage seek work in the uncovered sector.
What happens to wages and employment in that sector? Draw a graph to
show what happens, and analyze the effects on both wages and
employment in the uncovered sector.
Answer: The graph should show that the initial equilibrium wage in
the uncovered sector is $4 per hour and L = 220. Then the labor supply
curve shifts over by 20 to LS = -80 + 80W. The new equilibrium is W =
$3.80 per hour and L = 224. (4 points)
9. When the cost of dough-making machines fell by 10%, the demand for assistant
bakers fell by 15%. What is the cross-wage elasticity of demand for assistant bakers
in this case? Are assistant bakers and dough-making machines gross substitutes or
gross complements?
Answer: A 10 percent fall in the price of capital caused a 15 percent
fall in the use of assistant bakers so the cross wage elasticity is +1.5. A
positive elasticity indicates that the two are gross substitutes. (2 points)
10. A firm is considering hiring a worker and providing the worker with general
training. The training costs $1000, and the workers MRP L during the training period
is $3,000. If the worker can costlessly move to another employer in the post-training
period and that employer will pay a wage equaling the new MRP L , how much will
the training firm pay the worker in the training period?
Answer: Because mobility costs are low for employees of the firm,
the firm cannot recover the costs of providing general training so that the
workers must pay for the training. Hence, during the training period the
worker pays for the training by receiving a wage W = MRP L (during
training) cost of training = $3000 - $1000 = $2000.(1 point)
11. The supply of labor is given in the following table for Teddys Treats, a dog
biscuit company, which is a profit-maximizing monopsonist.
Offered Wage($)
4
5
6
7
8

Supply of Labor(Number of
Hours)
18
19
20
21
22

a. Calculate the total labor cost and the marginal expense of labor for each
level of employment.

b. Draw the supply of labor curve and the marginal expense of labor curve.
Answer: a. (10 points)
Offered
Wage($)
4
5
6
7
8

Supply of
Labor(Number of
Hours)
18
19
20
21
22

Total Labor Cost

($)

Marginal Expense
of Labor

72
95
120
147
176

-23
25
27
29

b. (4 points)

12. Teddys Treats, the dog biscuit company in Problem 11, has the following MRP L:
Number of Hours
18
19
20
21
22

MRPL
29
27
25
23
21

a. Add the marginal revenue product curve to the drawing in Problem 11.
Answer: See downward sloping dotted curve above which is also the
demand for labor curve. (2 points)

b. If Teddys Treats is maximizing profits, how many hours of labor will be

hired? What wage will be offered?
Answer: The profit-maximizing number of hours is 20 and
Teddys Treats will offer a wage of $6 per hour. (2 points)

13. Stella can work up to 16 hours per day at her job. Her wage rate is $8.00
per hour for the first 8 hours. If she works more than 8 hours, her employer
pays time and a half. Draw Stellas daily budget constraint.
Answer: (4points)

Stellas earnings are equal to the following:

[Number of hours (within first 8 hours) $8] + [Number of hours
(among next 8 hours) $12].
The budget constraint for the first 8 hours of work is the
segment to the right of the dotted vertical line at 8 hours. The
budget constraint for subsequent hours of work is the segment
to the left of the dotted vertical line at 8 hours.

14. Suppose a single parent can work up to 16 hours per day at a wage rate
of $10.00 per hour.
Various income maintenance programs have been developed to assure
a minimum level of income for low-income families. Aid to Families with
Dependent Children (AFDC) was established with the Social Security Act of
1935. The family was given an income subsidy depending on family size.
Under this program, the familys benefit was reduced by $1 for every dollar

earned. Suppose the maximum subsidy for the single parent described above
is $40.
a.
Draw the daily budget constraint without program participation for the
single parent described above.
b.
On the same graph, draw the daily budget constraint under AFDC for
the single parent described above.
c.
What effect might this program have on the incentive to work (i) for
those with steep indifference curves who are not working; (ii) for those with
steep indifference curves who work less than 4 hours a day; (iii) for those
with flat indifference curves who work more than 4 hours a day?
Answer:

(a) and (b). (5 points)

c.
Those with relatively steep indifference curves, who were
not working before, will still not work with the subsidy; with the
subsidy, their effective wage rate is zero. If the maximum AFDC
subsidy is $40, eligible participants who would work up to 4 hours
per day can attain a higher utility if they choose to receive the
subsidy under AFDC and not work at all. (2 points)
Beyond 4 hours of work, money income would be higher if
the person worked. This encourages some eligible individuals to
refuse program participation and work instead. These individuals
who continue to work have relatively flat indifference curves. (2
points)