Name ________________________________________
ECO361: LABOR ECONOMICS
FIRST MIDTERM EXAMINATION
September 28, 2011
Prof. Bill Even
DIRECTIONS.
The exam contains a mix of short answer and essay questions. Your answers to the 23 short
answers (3 points each) should be listed on the answer sheet attached to the end of the exam.
Your answers to the essays (40 points total) should be provided in the space beneath each
question.
Consider the data below for September August 2011 to answer the 3 questions that follow.
(in 1000s)
139,627
153,594
Number employed
Civilian labor force
Civilian non-institutionalized
population
239,871
Based on the data provided, provide numerical estimates of
1. the unemployment rate (to nearest tenth of a percent)
2. the labor force participation rate (to the nearest tenth of a percent)
3. Given the above information, suppose that 500,000 people who were not employed and
searching for work become discouraged and quit looking. The effect of this change would be
that the unemployment rate would (rise, fall, not change) and the labor force participation rate
would (rise, fall, not change).
a. rise; fall
b. fall; fall
c. fall; not change
d. none of the above.
4. Between 2002 and 2011, median weekly earnings in the U.S. rose from $610 to $756 in
current dollars, but from $336 to $337 in constant (1983) dollars. Based on this information,
how much higher are prices in 2011 than 2002? (Give your answer to the nearest one-tenth of
a percent).
5. Using the information provided in the previous question, how much would a person have to
earn in 1983 to have the same purchasing power as provided by $756 in 2011? (Give your
answer to the nearest dollar.)
Suppose that the hourly output of a car wash is given by the table below:
# of workers
1
2
3
4
Output
4
9
12
14
Assume that the firm charges $5 for each car wash and a worker earns $12 per hour.
6 what is the marginal revenue product of the second worker?
7. what is the profit maximizing number of workers?
Suppose that the MP of labor and capital are 20 and 80, respectively and their respective prices
are $20 and $90. Also, assume that the price of each unit of output is $.50.
8. If the firm wants to keep production constant and minimize cost, it should:
a. use more labor and less capital.
b. use less labor and more capital.
9. Based on the information provided, if the amount of capital is fixed, to maximize profits the
firm should:
a. use more labor
b. use less labor
c. use the same amount of labor.
10. At most construction projects, there are laborers and carpenters. The laborers perform
most of the low skilled work (e.g. carry lumber, clean up) while the carpenters do more of the
high skilled work (e.g. measuring, finish work). Suppose that changing market conditions lead
to a large increase in wages for carpenters. This will lead to a substitution effect that
(increases, decreases) the demand for laborers and a scale effect that (increases, decreases)
the demand for laborers.
a. increases, decreases.
b. increases; increases.
c. decreases; decreases.
d. decreases; increases.
11. Carpenters and laborers are more likely to be gross complements if:
a. the demand for construction projects is more elastic.
b. carpenters are a larger share of the total construction costs
c. laborers are not capable of doing most of the work that carpenters do.
d. all of the above.
12. The proposed jobs program from President Obama would reduce payroll taxes paid by
employers. This lower tax rate would have a larger positive effect on employment in industries
where labor demand is (elastic, inelastic). It would have a larger positive effect on wages in
industries where labor demand is (elastic, inelastic).
a. elastic; elastic.
b. elastic; inelastic.
c. inelastic; elastic.
d. inelastic; inelastic.
13. Which of the following conditions makes labor demand more elastic?
a. labor is a larger share of the total costs of production.
b. capital is a poorer substitute for labor.
c. the substitutes for labor have more inelastic supply.
d. all of the above.
14. Suppose that several mergers in the shipping industry cause it to become much less
competitive in the product market. As a result, we would expect that labor demand would
become more (elastic, inelastic) because the (scale, substitution) effect of a wage increase
would become (larger, smaller).
a. elastic; scale; larger
b. inelastic; scale; smaller
c. inelastic; substitution; smaller
d. elastic; substitution; larger
e. none of the above.
15. If the quantity of steel workers demanded falls from 5,000 to 4,500 when the equilibrium
wage increases from $10.00 per hour to $11.00 per hour, the own-wage elasticity of demand
for these workers is ____. (Use mid-point formula and round answer to nearest one hundredth,
e.g. 3.72).
16. Suppose that a firm pays workers $20 per hour and buys each worker a health insurance
policy that costs $300 per month. Assuming the firm holds total output constant, which of the
following would cause the firm to decrease the number of workers but increase the number of
hours per worker?
a. an increase in the hourly wage rate or an increase in health insurance premiums.
b. an increase in the hourly wage rate or a decrease in health insurance premiums.
c. a decrease in the hourly wage rate or an increase in health insurance premiums.
d. a decrease in the hourly wage rate or a decrease in health insurance premiums.
17. Recall our class discussion of the black lung trust fund for coal miners which was to be
financed by either a payroll tax or a coal tax. Compared to the miners in the surface coal
industry, those in the underground coal industry:
a. favored a payroll tax to finance the trust fund because the scale effect would be much
smaller in the underground coal industry.
b. opposed a payroll tax to finance the trust fund because the substitution effect would be much
smaller in the underground coal industry.
c. opposed to using a payroll tax to finance the trust fund because the scale effect would be
much larger in the underground coal industry.
d. opposed a payroll tax to finance the trust fund because the substitution effect would be much
larger in the underground coal industry.
18. A monopsony can hire one worker at a wage of $5, two workers at a wage of $6 each, three
workers at $7 each, and so on (each added worker adding one dollar to the wage rate). If the
marginal revenue product for all workers is $16, what wage will it pay?
a. $10
b. $11
c. $16
d. $17
19. When a firm hires a fourth worker, its wage rate goes from $80 a worker to $90. The
marginal revenue product of the fourth worker is $100. If the firm hires the fourth worker, its
profits
a. will increase by $10.
b. will increase by $20.
c. will decrease by $10.
d. will decrease by $20.
20. Assuming an interest rate of 8%, the present value of a contract that pays $50,000 per
year with payments at the end of the 1st, 2nd, and 3rd years would be _____ (round your answer
to the nearest dollar).
21. A quasi-fixed labor cost is
a. a cost that increases with number of workers, but not hours per worker.
b. a cost that increases with hours per worker, but not number of workers.
c. a cost that increases with both number of workers and hours per worker.
d. none of the above.
Table 5.1 Two-Period Training Model
22. A profit-maximizing firm which wants to provide firm-specific training to its workers will pay
________ in the training period and ________ after training is completed. (See Table 5.1 for
definitions of abbreviations.)
A) W*; W*
B) more than W*; less than MP1 but more than W*
C) less than W*, less than MP1 but more than W*
D) more than MP1; more than MP2
23. A profit-maximizing firm which wants to train its workers during the first period CANNOT
(see Table 5.1 for definitions of abbreviations)
A) equate the present value of the marginal product of labor to the present value of
expenditures.
B) allow WO + Z - MP1 to be greater than zero.
C) allow W1 to be greater than MPl.
D) allow Z to be greater than WO.
Answer any 4 of the first 6 questions.
1. (6 points) Until the mid-1970s, the reserve clause was common in many professional sports
contracts in the U.S. and restricted a player’s right to negotiate with teams. For example, in
baseball, the reserve clause bound a player to his team for as long as the team, not the player,
desired. The reserve clause in baseball was abolished in baseball in 1975 and replaced by
free agency. With free agency, if a player is in the major league for six years, he can negotiate
with any other team and is free to change teams.
Prior to entry in the major leagues, most players spend some time in the minor league where
skills are developed. Assuming wages of minor league players are not regulated, how and why
would you expect the abolishment of the reserve clause to affect the wages of minor league
players?
The reserve clause made it possible for teams to pay players below their MRP after the minor
leagues and offset the fact training costs plus wages exceed the player’s MRP in the minor
league. With elimination of the reserve clause, teams will have to pay a player their full MRP
after the training from the minors is complete or risk losing the player to other teams since the
training they receive is general and the player’s MRP should be similar across teams.
Consequently, since the training is general and the team can no longer pay less than the MRP
after the player becomes a free agent, the team will have to make the player pay for more of the
training in the minors by reducing their pay.
2a. (3 points) Describe what is meant by “deferred pay” and give one example of a way that a
firm explicitly defers pay.
Deferred pay is when a firm pays a worker less than his best alternative wage (Marginal
revenue product) early in her career, but above her best alternative wage later in the career. To
be competitive with outside offers, the present value of the deferred pay must match the present
value of the best alternative. A firm can explicitly defer pay with pension promises, or a
promise of retiree health care that don’t vest until a worker stays with a firm for a sufficiently
long period of time. The firm could also provide the worker with stock options that can’t be
exercised until the worker has been with the firm for a sufficiently long period.
2b. (3 points) Explain why a firm’s training investments affect whether it offers deferred pay.
If a firm makes an investment in specific training, it must pay the worker less his MRP with the
firm after the training after the training is complete, but above his MRP at the worker’s best
alternative – unless the firm can prevent the worker from leaving for better offers. At the same
time, the firm must offer a pay package that is the same or better in terms of its present value,
Since it must pay above what the worker can elsewhere after the training is complete, it can pay
less than the best alternative early in the career.
3. (6 points) Over the past 20 years, health insurance costs have been rising faster than
wages. For firms that provide workers with health insurance coverage, how is this likely to
affect average hours worked by the typical employee? Explain using the relevant theory of the
optimal mix between hours and workers developed in class.
A firm achieves the optimal (cost minimizing) mix of hours and workers by equating
ME(N)/MP(N)=ME(H)/MP(H) where ME is marginal expense, MP is marginal product, N is
number of workers and H is number of hours per worker. Since health insurance is a quasifixed cost and it is rising faster than wages, ME(N) is rising faster than ME(H). Thus, the firm
will respond to the more rapid increase in ME(N) by conserving on number of workers (which
drives up MP(N) and requiring more hours per worker (which drives MP(H) down). This will
restore the equality necessary for an optimal mix of hours and workers.
4. (6 points) Numerous studies have investigated the short run effect of higher minimum
wages on employment, but most economists agree that the short run and long run effects will be
different. Given what you know about the distinction between the “short run” and “long run”,
would you expect the employment loss from a minimum wage hike to be larger in the short run
or long run? Why?
In the short run, labor is variable but capital is fixed. Consequently, in the short run, an
increase in the minimum wage will have only a scale effect as increased costs lead to a
decrease in the quantity of output produced and a reduction in labor demanded. In the long
run, capital is variable and there will be both a scale and substitution effect. The substitution
effect further reduces the quantity of labor demanded because an increase in the minimum
wage will lead firms to use more capital and less labor to produce any given level of output.
Therefore, the effect of a minimum wage increase on employment is greater in the long run
since both the substitution and scale effect reduce employment. In the short run, only the scale
effect reduces employment.
5. (6 points) Prior to 1979, the Interstate Commerce Commission (ICC) regulated entry into
significant portions of the trucking industry. Beginning in 1979, deregulation began which
opened trucking to much more competition and allowed independent operators to compete with
many of the commercial carriers. Explain how and why you would expect this deregulation to
affect the difference between the earnings of union and non-union truckers.
Deregulation of the trucking industry made the industry much more competitive and thus made
product demand more elastic for any trucking firm. As a result, labor demand becomes more
elastic since any increase in wages will result in a larger loss of sales in a more competitive
product market. More elastic product demand reduces union bargaining power because it
means that any given wage increase will create more job loss. Consequently, we would expect
deregulation to reduce the union wage premium.
6. (6 points) Draw a diagram showing the labor supply and marginal revenue product curve for
a monopsonist. Identify the profit maximizing wage and employment as W1 and L1. Use the
same diagram to explain how a minimum wage could increase employment. Be sure to provide
a verbal description of how your diagram illustrates this point.
MEL
LS
W3
W2
W1
MRP
L1
L2
L3
Without a minimum wage, the monopsony will maximize profits by hiring L1 workers and pay
W1 to equate MRP=MEL. With a minimum wage of W2, the MEL curve becomes horizontal at
the minimum wage (red line) until it intersects the LS curve at L3 – at which point the MEL
jumps to the old MEL curve. The reason is that the minimum wage means that the firm’s labor
supply curve becomes horizontal at W2 until employment goes beyond L3. With the new MEL
curve caused by the minimum wage at W2, the firm will increase employment to L2. If the
minimum is increased far enough (e.g. above W3), employment will drop below L1
Answer both 7 and 8
7. (8 points) President Obama’s proposed American Jobs Act would introduce a number of
initiatives to create jobs. One proposal would give employers a tax credit of 6.2% for any
increase in payroll between 2011 and 2012. For example, if an employer had $1 million of
payroll in 2011 and increased payroll to $1.5 million in 2012, the employer would receive a tax
credit of .062*(.5 m).
Suppose that a Senator from Iowa is opposed to the tax credit because it will generate a smaller
percentage increase in jobs in Iowa than in the average state. He bases his argument on two
facts: (1) Iowa is an agricultural state that sells its goods in a very competitive global market,
and (2) agricultural production is relatively land and capital (not labor) intensive. If you agree
with the “facts”, do you agree with the Senators assertion that the tax credit will create fewer
jobs (in percentage terms) in Iowa? Explain using the relevant theories developed in this
course.
The payroll tax credit reduces the net wage paid by employers and will create more jobs if labor
demand is more elastic. The fact that Iowa is an agricultural state selling in very competitive
markets should make labor demand more elastic since the scale effect of any wage reduction
would be greater. Consequently, this Iowa fact is inconsistent with the Senator’s claim. On
the other hand, if agriculture is not labor intensive, labor demand will be more inelastic since the
scale effect of a wage cut will be relatively small. Therefore, this Iowa fact is consistent with the
Senator’s claim. Overall, the senator is “half right and half wrong.
r
8. (8 points) Another initiative in the American Jobs Act would allow businesses to deduct 100
percent of the cost of new capital purchases in year it is purchased. This accelerated
depreciation provides significant tax savings on capital purchases and reduces the effective
price of capital. A representative from California has many constituents who work in the wine
industry. If the representative wants to improve jobs in the wine industry, should he vote for or
against this accelerated depreciation rule? Justify your answer using the relevant theories
developed in this course.
Accelerated depreciation reduces the price of capital. This could either increase or decrease
the demand for labor in the wine industry. The scale effect of lower priced capital is to increase
the supply and price of wine, lead to increased production, and drive up the use of both labor
and capital. On the other hand, the substitution effect is that lower priced capital will lead firms
to replace workers with machines. On net, the effect depends on which effect dominates. If
the substitution effect dominates, workers and capital are gross substitutes and the senator
should vote against the bill since it will reduce employment. If the scale effect dominates,
workers and capital are gross complements, and the senator should vote for the bill since it will
increase employment.
NAME (Please print) __________________________________________________________
Answer Sheet
1 9.1%
2 64.0%
3 B
4 23.6%
5 $337
6 $25
7 3
8 A
9 B
10 A
11 D
12 A
13 A
14 B
15 -1.11
16 C
17 C
18 A
19 D
20 $128,855
21 A
22 C
23 C