Labor Economics

Labor Economics
Exercises
1. Labor Supply
Question 1.
Suppose that the Government is considering implementing the following support
program: if the individual is unemployed receives an income subsidy in the amount of
X Euros, however, if the individual starts working loses the right to receive this subsidy.
Show, with a graphical representation, that this policy can lead the individual to stop
working.
Suggestion: For simplicity, assume that the individual does not receive non-wage
income.
Question 2.
If Joana works up to 40 hours per week, she earns a wage of 15 per hour. Beyond the
40h, for each overtime hours she receives 30/h. We also know that Joan has to pay a
wage income tax rate of 20%.
When Joana is working, she has to leave their children to the care of a babysitter, who
she pays 4 per hour. Additionally, Joana receives a weekly subsidy of 80 from the
Government.
Knowing that Joana has 168 hours available to allocate between work and leisure,
represent graphically Joanas budget constraint.

Question 3.

John has the following utility function:

U(C,L) = ( C 200 ) ( L 80 )
We know that John has 168 hours per week available to allocate between work (h) and
leisure (L) and that he earns a net wage of 5 per hour. Admit that, each week, he earns
non-wage income of 320 .
.
a) Derive and represent graphically Johns budget constraint.
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Labor Economics
b) What is the marginal rate of substitution (MRS) when L=100 and is on the
budget constraint?
c) Define reservation wage. What is the reservation wage for John?
d) What is the optimal choice of consumption (C) and leisure (L)?
Question 4.

Miguel's preferences are given by:

U(C,L) = C L
Consider that Miguel has 168 hours available per week and that he earns 10 per hour.
a) What is the optimal choice of consumption (C) and leisure (L)?
b) If the government implements a policy where it pays X euros to all unemployed
individuals and 0 for all the employed, which is the value of X that will impel
Miguel to leave the labor market?
Question 5.

The government of country X is concerned with the access of the poor individuals to
legal services. Thus, the government implemented a policy which requires that lawyers
devote 5% of their work time to provide free services to the poor individuals.
a) (3 points) Represent graphically the impact of this policy on Johns temporal
budget constraint, who is a lawyer. Justify.
Hint: Assume that Johns non-wage income (V) is zero.
b) (5 points) The Lawyers Association issued a statement arguing that this policy
provides a clear disincentive to work. Do you agree that this measure always
leads to a decrease in the number of hours of work? Illustrate with a graph.
Decompose and explain the substitution effect and the income effect.

Question 6.

50% cut in overtime payments until 2013

The Government wants to cut in half, by the end of 2013, the value of the wages paid to
public employees for overtime, according to the preliminary version of the law
proposal, which Lusa had access.
The document aims to change the values of hourly remuneration regarding the payment
of overtime provided on normal working day as long as we are under the Program of
Economic and Financial Assistance to Portugal , i.e., until the end of 2013.
Source: www.jn.pt; 12/10/2011 - 23:19
a) Discuss, carefully explaining the concepts used, what could be the impact of this
law proposal in the labor supply of a worker who works overtime. [maximum
10 lines]
b) Discuss, carefully explain the concepts used, what will be the impact on the
demand for capital in the long-run assuming a technology in which inputs are
perfect complements. [maximum 10 lines]
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Labor Economics
Question 7.
PSD (Social Democratic Party) wants unemployed individuals to do unpaid work
three days a week
If the proposal of PSD to make mandatory the provision of a solidarity tax is
approved, the unemployed individuals receiving unemployment benefit will be required
to provide service to the community in a public institutions or in an institution of the
social sector for 15 hours per week,
Source: www.jornaldenegocios.pt; 17/05/2010
Carefully explaining all the concepts used, represent and compare, on the same graph,
the situation of an individual receiving unemployment benefit who is not required to
provide community work and an individual to whom this solidarity tax is required.

Question 8.
Joana's preferences for consumption (C) and leisure (L) are given by:
U(C,L) = C L
Joana has 168 hours available per week and does not have any non-wage incomes.
Currently, the optimal choice of Joana is to enjoy 84 hours of leisure and spend 840
on consumption. If the government implements a policy that pays X euros to all
unemployed individuals and 0 to all employees, which is the value of X that will drive
Joana to stop working? Justify using a graph.

Question 9.

Joss preferences for consumption (C) and leisure (L) are given by:
U(C,L) = C0,2 L0,8
It is known that Jos has 168 hours per week available to allocate between work (h) and
leisure (L) and earns a net wage of 4 per hour. Also assume that Jos doesnt have any
other non-wage incomes.
a) Derive and represent graphically Joss budget and time constraint.
b) What is the optimal choice of consumption and leisure? How many hours will
Jos work per week? What is his monthly income?
c) Read carefully the following text:
[The beneficiaries] lose the right to the unemployment benefit if, unjustifiably:
refuse a suitable employment or the Personal Employment Plan
(...)
Do not present to an entity to which they have been referred to by the Job
center (eg., for an interview).
Fail more than twice the duty to:
- Actively seek for employment, (...)
Source: Guia Prtico Subsdio de Desemprego, Instituto da Segurana Social, Fevereiro
de 2009
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Labor Economics

Discuss the reasons which lead the policymaker to include these restrictions in the
unemployment subsidy. In this context, suggest a maximum monthly value for the
unemployment benefit paid to Joseph

Question 10.
Portugal, Spain and Greece will have to reduce wages
Portugal, Spain and Greece, countries facing difficulties in their public accounts, will
have to take sacrifices, such as reducing wages to increase competitiveness (...). This is
the reading of the economic environment that is going through some European
countries and, according to the chief economist of the International Monetary Fund
(IMF), Olivier Blanchard, can lead to 'great sacrifices'.
Source: www.agenciafinanceira.iol.pt; 2010-02-02; 11:18
a) Suppose that real wages decrease in Portugal. In a broadcasted debate about the
labor market, one commentator makes the following statement: The statistics
may be incorrect because the real wage is decreasing and the number of hours
worked is increasing. Discuss the statement of the commentator, applying the
appropriate economic concepts.
b) Explain and represent graphically the optimal decision of the worker before and
after the reduction of the real wage assuming that, at the new equilibrium, the
number of worked-hours increases. Assume further that the employee does not
receive other non-wage incomes.

Question 11.
Comment carefully the following statements using a graph, when necessary:
a) The recent increase in the IRS (Portuguese tax on wage incomes) will decrease
the individuals incentive to work.
b) A decrease in non-wage incomes will reduce the individuals incentive to work.

2. Labor Demand
Question 1.
Firm ABC produces its product in a perfectly competitive market, using as inputs L
(labor) and K (capital) and with the following production function:
Q(L,K) = 6KL2-L3
In the input markets there is also perfect competition. Additionally, it is known that in
the short-run the fixed input (K) is equal to 2 units.
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Labor Economics
It is assumed that the equilibrium price of the final product is 10 m.u. and the price of
the variable factor (L) is 50 u.m.
a) Determine the analytical expressions of the Value of the Marginal Product and
the Value of the Average Product of the variable factor. Represent graphically
and explain the economic meaning of these two concepts.
b) Determine the number of employees that the firm will hire in the labor market if
it wants to maximize the profit.
c) As you know, the entrepreneur can always choose not to produce. What is the
wage rate that drives the firm not to produce
d) What is the firms short-run demand curve. Represent graphically.

Question 2.
Assume that the long-run production function of a firm is given by:
Q= 3K1/3L1/3
Both the product and the inputs markets are perfectly competitive, with r = 1, w = 0.5
and P = 1.
a) Determine the combination of inputs K and L that maximize the firms profit
and the associated level of output. Represent graphically.
b) Suppose that the wage increased to 1. Determine the new combination of inputs
that maximizes profit and new level of output. Represent graphically.
c) Represent graphically the substitution effect and the scale effect. Give the
economic intuition behind these effects. Classify the inputs.
d) What is the impact on the demand curve for capital caused by this increase in the
wage?

Question 3.
Suppose that there is perfect competition in the market for the production of carpets.
Firm Alfa is the only firm that is installed in a county within the country where the
workforce has no other source of wage income.
The production technology of carpets is given by:
Q(L,K) = 24,4LK-4L2
The labor supply is the following:
W(L) = 240+6L
The price of each meter of carpet is 1 m.u. and the price of the input capital is 1110 m.u.
It is known that the firm Alfa uses, at the moment, 100 units of capital and 120
employees.
Assuming that the firm operates in the short-run, where the capital is fixed capital,
answer the following questions:
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Labor Economics

a) What is the profit that the firm earns now?

b) Is the firm maximizing its profit? If not, what is the maximum profit that the
firm could get?
c) Without doing calculations, on the same graph, identify the perfect competition
equilibrium in the inputs market. Comment.

Question 4.
ABC is the only producer of an innovative product and has to meet the global demand
for the product that has the following expression:
Px = 400 - X/8
The production process is characterized by the following production function:
X = 2KL
Given the complexity that surrounds the production process, the labor is highly
specialized and offered according to the following function:
W = 200+2L
It is known that the firm is using 4 machines (K) acquired at unitary price of 50 000
m.u.
What is the optimal amount of labor that the firm must hire and which is the maximum
profit that the firm can get?

Question 5.
ABC is a firm that produces computer components, presenting the following production
function: Y = KL - L2
The firms total revenue is given by: TRY = 100Y
It is known that the labor supply is given by W(L) = 500 + L and that the firm currently
uses 50 units of the input capital acquired at the price of a 500 m.u.
a) Present and interpret the condition that will allow firm ABC to determine the
number of workers that maximizes its profit.
b) How many workers should the firm hire? What is the wage? What is the
quantity of output produced? What is the firms profit? Justify and represent
graphically your answer.
c) An employee of the firm suggests that there was a mistake in the estimation of
the production function and that the real firms technology is given by: Y = K +
L. Therefore, this employee says that in the long-run, the firm must make radical

Labor Economics
adjustments in the used quantity of inputs K and L. Do you agree with this
employee? Justify.

Question 6.
The FCP Ltd firm produces soccer balls and has the following production function:
Q(K,L)= 200KL-2L2
In the short run, the amount of capital (K) is fixed at 10 units. The price (P) of each
soccer ball is 2 euros and the wage is given by:
W(L)= 200+2L.
Determine and compare the equilibriums in monopsony and perfect competition. Plot
(in the same graph) and explain carefully the differences between the two equilibriums.

Question 7.
A million robots to replace workers at Foxconn
The group Foxconn Technology, during the next three years, will replace workers by
one million robots. The firm from Taiwan, responsible for assembling the IPhone and
IPad, justifies that this change is due to the rising costs of labor..
The firm, which has been questioned about their working conditions, is planning to use
robots for simple tasks in the assembly line, such as spraying and welding, carried out
mainly by workers, said the president of the Foxconn, Terry Gou.
Source: www.jn.pt; 02/06/2011
Which type of workers is the most affected by this measure and why? Explain carefully
the effects and represent graphically.

Question 8.
Suppose a technology in which there are only two factors of production, capital (K) and
labor (L) that are perfect complements. Assuming an increase in the price of labor
explain and decompose the substitution effect and the scale effect.

Question 9.
The firm APOLLO, Ltd. is the only producer of an innovative system that uses solar
energy. The manufacturing process uses two inputs, labor (L) and capital (K) and can be
represented by the following production function:
X = KL
The demand for the product is given by: P(X) = 200 - X

Labor Economics
Since this is an extremely innovative technology the labor work used in the production
process requires very specific training and is highly specialized. The labor supply
function is given by:
W(L) = 100 + L
It is known that, currently, the firm is using 2 units of capital (K) acquired at the price
of 300 m.u.
a) Identify the market structure that the firm faces in the product market and in the
input markets. Justify.
b) What is the optimal number of employees (L) that the firm must hire in order to
maximize its profit. Justify carefully.
c) What is the maximum profit that the firm will get? Justify.

Question 10.
Cassava starch is used in the chemical, food, metallurgical, textile and pharmaceutical,
industries. Suppose that the market for cassava starch is perfectly competitive. The
company Cassava Ltd, dedicated to this production, is the only firm installed in rural
Malawi, where the working population has no other source of wage income.
The production technology of cassava starch uses three inputs cassava (M), work (L)
and capital (K) and can be represented by:
Q(M,K,L) = MKL-L2
The supply of labor in the region is given by:
W(L) = 500+2,5L
It is known that the price of cassava starch is 10 euros a tonne. The firm currently has
the input capital fixed in one unit and, in short-run the contractual conditions determine
that the acquisition of cassava is stable in a hundred tons per month.
Answer the following questions:
a) How many workers will the firm Cassava Ltd hire? What is the workers
monthly wage? Justify and represent graphically.
b) Suppose now that the firm is the only producer of cassava starch. Based on a
graph tell what would happen to the number of workers hired by the firm and to
the wage.

Question 11.
In 1992, the minimum wage in New Jersey increased from $4.25 to $5.05 per hour ()
Using information gathered by the employers, Card and Krueger (1994) concluded that
an increase in the minimum wage increased employment in New Jersey restaurants.
Source: http://en.wikipedia.org/wiki/Minimum_wage

Labor Economics
One of the hypotheses in the study is the existence of a monopsonist market. Explain
this hypothesis using a graph. Justify adequately.

Question 12.
With the decreasing price of new technologies, many analysts projected that firms
would fire workers replacing them with more capital intensive technology. However, it
is observed that employment increased instead of decreasing. Explain what is happening
in this market. Justify.

Question 13.
Discuss the following statement, adequately justifying your answer: After the
implementation of a minimum wage that has led to an increase in the market wage, it
was observed a decrease in the number of workers hired. This allows us to conclude that
the labor market is perfectly competitive.

Monitoring costs

Question 1.
The finantial group FIN, SA is the holder of two banks: the INVEST and the MONEY
that are involved in different activities. The MONEY - Commercial Bank is dedicated
to raising funds (deposits, mutual funds,...), the transfer of funds (bank loans) and other
services (bank guarantees, currency sales, periodic payments,...). The INVEST Investment Bank is dedicated exclusively to activities related to capital market.
The specifics related to capital market lead the productivity of individuals in the bank
INVEST to be much more variable than in the bank MONEY. Compiling data collected
by the Human Resources Department over the years, it was possible to classify
individuals into five levels of productivity:
A Very Bad
B Bad
C Medium
D Good
E Very Good
With the information collected, there were some difficulties in quantifying the output of
the individuals whose productivity was classified as Very Bad.
Tables 1 and 2 present the data on wages, the proportion of individuals of each type and
their average annual output (thousand euros) to the banks INVEST and MONEY,
respectively.

Labor Economics
Table 1 Type of workers in bank INVEST
Type
A
B
Proportion of individuals
0,1
0,2
Average annual output
?
0
Average Wage

C
0,3
50
40000/year

D
0,3
100

E
0,1
200

Table 2 Type of workers in bank MONEY

Type
A
B
Proportion of individuals
0,1
0,2
Average annual output
?
50
Average Wage

C
0,3
60
40000/year

D
0,3
70

E
0,1
90

It is also known that the average net revenue generated by a worker at the bank INVEST
is 15000/year and in the bank MONEY is 21500/year.
The Management of the group is considering the introduction of a set of systems to
control and monitor the productivity of workers that would help to identify and fire
individuals who are generating a loss in each of the banks. A preliminary study
commissioned by the Administration indicates that the costs of implementing this
monitoring system would amount to 1,000 per worker.
Considering the above information, answer the following questions:
a) Suppose that you work in the Human Resources Department of group FIN, SA
and that you are responsible to complete the missing information in Tables 1 and
2. What values would you suggest? Justify your answer.
b) The Administration asked your department for a reasoned opinion on the
implementation of the monitoring system. What would you respond to the
Administration?
c) The Administration has little confidence in the study on the costs of the
monitoring system, believing that this costs can be more or less than the amount
indicated. So, you were asked, for each bank, to determine the maximum value
of monitoring costs that make the implementation of the monitoring system
advantageous. Justify.

Question 2.
Assume that in the firm ABC there are two types of workers (type X and type Y) that
differ in their productivity. The firm has currently 600 employees and is considering
implementing a monitoring system to identify and fire workers that cause a loss to the
firm.
It is estimated that the monitoring costs are 5 thousand euros per year per worker. It is
known that the average productivity of workers of type X is 50 thousand euros per year
and that the productivity of workers of type Y is 20 thousand euros per year. The annual
average wage paid by the firm is 30 thousand euros.
How many employees and of which type should work at the firm in order to make the
implementation of the monitoring system worthwhile?
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Labor Economics
Question 3.
Consider the following article:
Microsoft creates a software to monitor employees
The American company plans to develop a computer system that, thanks to wireless
sensors, measure, all the time, the heart rate, body temperature, movement, facial
expression and blood pressure of the worker.
This type of technology, which allows the observation of workers, was until now limited
to pilots and NASA astronauts (...)
Source: http://www.cedosoft.com, January 17, 2008
Comment this excerpt explaining the circumstances in which it may be more
advantageous to implement a monitoring system of workers.

Choice between number of workers and the number of hours

worked

Question 1.
How will the bank of hours work
In practice, the bank of hours allows firms to adjust their production schedules to
production peaks asking their employees to do more hours in a given period. (...)
This system can be used in periods of low business activity, reducing the normal
working day, but without the reduction of wages. What remains is a credit of hours that
can be used when production increases or the economic activity grows. Thus, if the
bank of hours is applied at a time of great activity of the firm, the work schedule can
increases a maximum of two hours a day.
Source: www.dinheirovivo.pt; 17/01/2012
Discuss the importance of quasi-fixed labor costs when firms opt for the bank hours.

Question 2.
For the following questions choose the best answer:
1. Legislation requiring employer-provided health insurance for part-time workers
would probably _________ the employment of part-time workers and ________
the overtime of full-time workers.
(a) increase; increase
(b) increase; decrease
(c) decrease; increase
(d) decrease; decrease

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Labor Economics

2. A mandated increase in overtime pay is likely to

(a) raise the average costs of labor, even if all overtime hours were eliminated.
(b) cause an increase in labor hours due to the scale effect.
(c) cause employers to increase straight-time hourly wages to compensate
(because of the package agreed upon).
(d) cause an increase in labor hours due to the substitution effect.

3. A mandated increase in overtime pay is likely to

(a) cause employers to reduce overtime hours and convert them into added
employment.
(b) directly reduce the quasi-fixed costs per worker.
(c) lead to a reduction in employment if higher costs cause a large scale effect.
(d) lead to a reduction in employment if those who work overtime and those who
are unemployed are perfect substitutes.
4. An increase in quasi-fixed costs would probably lead to a(n) ________ in the
number of employees hired and a(n) _________ in the number of overtime
hours worked.
(a) increase; decrease
(b) increase; increase
(c) decrease; decrease
(d) decrease; increase
5. Which of the following is definitely NOT a quasi-fixed cost of labor?
(a) unemployment insurance
(b) health insurance
(c) overtime pay
(d) vacation pay
6. A quasi-fixed cost of labor is a cost that
(a) is expected to change over time.
(b) is proportional to the number of hours worked.
(c) is proportional to the number of workers hired.
(d) is proportional to the amount of capital used.
7. Which of the following event will likely lead a firm to use overtime rather than
hire new workers:
(a) the firm gets rid of its pension plan.
(b) the firm starts to pay for health insurance.
(c) the marginal productivity of all workers, new and current, increases 20%.
(d) both overtime and base pay increase 20%.

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Labor Economics

3. Education and Training

Question 1.
Consider the following excerpt from an article published online in Jornal de Notcias:
The law that locks the exit of plane pilots is insufficient
The Republics President admitted yesterday, not to be "sufficient" the law that locks
the exit of plane pilots from the Portuguese Air Force (FAP), most of which choose to
transfer to civilian airlines.
Cavaco Silva confronted by military leaders with the problem of scarcity of pilots,
during a visit to Monte Real Air Base, recalled having enacted a law amending eight to
twelve years the permanence of pilots in FAP. With this legislation a pilot who wants to
leave early will have to compensate the State.
[...]
Alexandra Serdio
Jornal de Notcias online, 18th October, 2007
Discuss the issues raised in the article and do not forget to identify the economic
problem(s) underlying and the possible solutions.

Question 2.
The company TEK, Inc. knows that, in the market, there are approximately in the same
proportion, two types of individuals that differ in their intelligence, ability and innate
skills:
- Individuals of type B (Bad): little diligent individuals with lower skills and low
productivity;
- Individuals of type G (Good): individuals very committed, capable and with high
productivity.
The following table shows the present value of wages (i.e., the discounted value of
wages throughout the entire working life) that the firm will be willing to pay for each
type of individuals:
Type of worker
Tipo B
Tipo G

Wage (actual value)

200.000
300.000

Since the firm cannot observe the worker type, it requires a signal for distinguishing
them. The firm believes that having higher education may signal and distinguish
individuals. Thus, the firm will adopt the following hiring policy:
- To the individuals with less than x years of higher education, the firm only pays
200,000 since it assumes that they are of type B;

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Labor Economics
- To the individuals with at least x years of higher education, the firm pays 300,000
because it believes that they are of type G.
Costs incurred during attendance of higher education are different for each type of
individual. An individual of type G has total costs (including psychological costs,
opportunity costs, etc..) with higher education of 20,000 per year. The individuals of
type B, facing greater difficulties in learning, support a total annual cost of 25,001.
Based on the information presented above answer the following questions (for
simplicity, assume that the discount rate is equal to 0):
a) In the absence of signaling, is there an adverse selection problem? Justify your
answer by explaining what is adverse selection and to what extent it can be seen
(or not) in this market.
b) A manager of TEK, Inc. suggested that the problem of identifying the workers
would be easily solved if, during the recruitment interview, the individual is
asked to which group it belongs. Discuss the suggestion of the manager.
c) Suppose that obtaining higher education does not bring any costs for both types
of individuals. What would happen?
d) According to the "theory of education as a signal" to what extent higher
education affects the productivity of individuals? Justify and compare with
"theory of investment in human capital."
e) Determine the minimum number of years of education (x) that the firm should
require in order for workers of type B do not wish to acquire the signal. Justify
your answer graphically.
f) Determine the maximum number of years of education (x) that the firm may
require in order for the type G workers still wish to acquire this signal. Justify
your answer graphically.
g) Considering your answers to the previous questions and assuming that markets
are perfectly competitive, which is the number of years of education (x) that the
firm will require in its recruitment policy? Justify.

Question 3.
Consider the following excerpt from an article published in a higher education magazine
on RVAE - Recognition and Validation of Learning Acquired by Experience
() The RVAE is also a symptom of the symbolic importance that academic
certificates have in society, implying the social recognition of the wisdom of
experience. This recognition weighs in the motivation of those who intend to start a
RVAE process but has also created in some schools (...), the fear that the process
involves the general devaluation of academic certificates (...)
Source: Slvia Ferreira; Ensino Superior N. 14 Revista do Sindicato Nacional do
Ensino Superior: Dezembro 2004 - Janeiro 2005
Based on the materials covered in class, discuss the issues raised in the article and do
not forget to explain the theory behind it.

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Labor Economics
Question 4.
Suppose there are two types of workers: workers of type B (Bad) and workers of type
G (Good). It is known that the acquisition of higher education will cost 20000 to
individuals of type B but only 8000 to individuals of type G.
The firms intend to use higher education as a mechanism for selecting candidates. The
firm plans to pay 25000 to the workers without higher education and X to graduated
workers. What values should X assume so that higher education could be properly used
as signal? Justify.

Question 5.
When Ken Hassey was hired by the Oakland Police Department, he signed a
conditional offer that required Hassey to repay $8,000.00 in training costs if he
failed to work for the Police Department for 5 years.
Source: http://blog.griegolaw.com (01/07/2008)
Based on the material covered during classes discuss the issues raised in the excerpt.

Question 6.
Restrictions on training
(...) The underlying problem is that any firm that pays the training has the risk of seeing
their skilled workers being caught by its competitors. (...)
Source: www.economist.com; 26/05/2011
Comment the excerpt according to the theory on who should pay the training costs.

Question 7.
Usually the employment contract establishes a Permanency Pact in which the
employee agrees not to cancel the contract for a certain period. Explain the context in
which this type of arrangement makes sense.

Question 8.
Analyze the likely impact of the following events on workers decision to invest in
human capita, ceteris paribusl:
a) Increase their discount rate.
b) Increase the retirement age from 65 to 70 years.

Question 9.
Discuss the following statement, explaining properly: In the model of specific training
we observed that the employee goes through a period of underpayment followed by a
period of overpayment."
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Labor Economics
Question 10.
Consider the following excerpt:
Professional car drivers require amendment of the law which requires the Certificate
of Professional Aptitude
Close to a hundred professional drivers manifested today against the Department of
Transportation requiring modification of the law that requires workers to have the
Certificate of Professional Aptitude (CAM) in September (...)
But to have these documents we are required to have 35 hours of training (...) [said
the leader of the Federation of Trade Unions of Transport and Communications
(FECTRANS)] (...)
At the origin of the workers discontent is the law of 27 May, according to which the
charges related to the acquisition of the initial qualification and periodic training
should be the paid by the professional drivers
Source: Jornal Sol online (8 de Julho de 2009)
Discuss the issues raised in the extract regarding to whom should pay for the costs of
training.

Question 11.
Considering the concepts presented in classes, discuss following figure, justifying your
answer.

Source: www.CartoonStock.com

Question 12.
John and Louis are considering taking training in order to improve their knowledge
about the firms inventory management. Assuming that this is a specific training and
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Labor Economics
that John and Louis are identical in everything else except that John is older, married
and with children:
a) Explain what is specific training;
b) Discuss who should pay for training.
Justify all your answers.

Question 13.
Classify the following statements as true or false, always briefly justifying your
answer: The empirical finding that women are less promoted than men implies that
there is discrimination.

4. Wages, incentive systems and motivation: compensating

differientials; variable pay; promotions; seniority; efficiency wages
and teamwork
Compensating Wage Differentials
Question 1.
On the labor market for the perfume industry there are two types of workers, some who
do not like the smell of perfume that is felt in factories and others who like the smell of
perfume as long as this is not too intense and exaggerated. It is known that there is no
cost associated with reducing the smell of perfume in the factories.
a) Represent graphically the indifference curves of the two types of workers.
Explain the shape of the curves.
b) Represent graphically the iso-profit curves. Explain their format and identify the
relevant iso-profit.
c) Explain and represent graphically the market equilibrium, identifying the
compensating wage differential.

Question 2.
The increase in salary earned by individuals with higher level of education can be seen
as a compensating wage differential. Individuals will only be willing to invest in
education if they have the expectation of receiving higher wages. Thus, they have to
consider the choice between a job that pays a lower wage but requiring less education or
a job that pays a higher wage but also requires a higher level of education.
Applying what you have learned about the theory of compensating differentials, answer
the following questions:
a) Plot the map of individuals indifference curves. Explain the shape of the curves.
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Labor Economics
b) Plot the indifference curves of two individuals with different aversion degrees
for investing in education. What could explain these differences between
individuals?
c) Plot the iso-profits curves. Explain their format and identify the relevant isoprofit.
d) Comment the following statement: The slope of the iso-profit may differ from
firm to firm.
e) Explain and plot the market equilibrium.
f) As you have seen from classes, the Human Capital Theory and the Theory of
Signaling have different perspectives on the role of education. Does the
previous analysis allow you to give a definitive answer about which theory is
right?

Question 3.
a) Represent graphically the indifference curves of two individuals with different
aversion degrees to investment in education. Justify. What reasons can explain
these different degrees of aversion?
b) Suppose a market where education is not valued by firms, i.e., firms are
indifferent between individuals with more or less education. Plot the iso-profit
curves and adequately explaining the shape of the curves.
c) Explain and represent graphically the market equilibrium.

Question 4.
Consider the following picture:

In the absence of regulations on the risk of accident, the situation in the market is the
one represented above. Assume now that the Government imposes a rule that sets the
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Labor Economics
maximum level of risk in Rmax. Explain in detail, using the economic concepts
discussed during classes, the effects of this rule on individuals and on firms.

Question 5.
Depressions and new cancers are the diseases of the decade
(...) The increase of psychosocial diseases is one of the alerts of ACT (Autoridade para
as Condies de Trabalho) for the National day of Prevention and Safety at Work,
which is celebrated today. One of the slogans will be also protect you against what
you do not see. (...)
Source: www.ionline.pt; 08/04/2010
Comment the excerpt and the motto: also protect you against what you do not see
according to the Theory of Compensating Wage Differentials and its assumptions.

Question 6.
The additional wage premium earned by the workers with more education may be seen
as a compensating wage differential. In this context assume a scenario with two workers
and two firms and assume that in equilibrium the worker A decides to do the six years
of schooling and worker B chooses 9 years of schooling.
Analyze the impact on workers and on firms of a mandatory schooling policy of 12
years. Plot and compare the equilibrium before and after the introduction of the policy.

Question 7.
Consider the theory of compensating wage differentials with respect to the choice
between wage and the risk of accident.
a) Represent graphically the market equilibrium, identify and explain what
constitutes the compensating wage differential. Justify.
b) Describe the assumptions on which the theory of compensating wage
differentials is based.
c) Discuss the following statement: "By distorting the market equilibrium, the
introduction of mandatory rules on hygiene and safety at work will reduce
welfare."

Question 8.
Consider the theory of compensating wage differentials applied to investment in
education:
a) Explain and represent graphically the offer curve.
b) Represent graphically the indifference curves of two individuals (A and B) in
which the individual A has a higher degree of aversion to investing in education.
Discuss the reasons that may explain this difference between individuals?
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Labor Economics
c) Explain in detail and represent graphically the market equilibrium knowing that
one of the individuals will complete 9 years of schooling and the other will
complete 17 years of schooling.
d) Consider the following news:
Mandatory schooling changes to 12 years
The Council of Ministers approved on Thursday, generally the proposed law that
extends from nine to 12 years of mandatory schooling (...)
Source: http://aeiou.visao.pt, April 23, 2009
What is the impact of this public policy on the market equilibrium and on the well-being
of individuals A and B? Justify your answer and represent graphically.

Question 9.
Risk subsidy and performance evaluation lead municipal workers to the streets of
Lisbon
The failure to update the subsidy for unsanitary, painfulness and risk and an alleged
"unfair treatment" in the application of performance evaluation by the Lisbon
municipality motivated today two different concentrations of workers.
From 09:30, the Union of Workers of the Municipality of Lisbon is waiting for more
than five hundred employees in front of Paos do Concelho to claim for an increased
risk subsidy, which they claim to be out of date since 2002.
Source: www.ionline.pt; 24 de Fevereiro de 2010
Comment and justify your answer graphically: The payment of a subsidy for unhealthy
conditions, hardship and risk always benefits workers.

Question 10.
On the labor market for the perfume industry workers like the smell of perfume since
this is not too intense and exaggerated. It is known that to reduce the smell of perfume
in the workplace, the firm has to support an extra cost facing an increasing marginal
cost with the reduction of the smell.
a) (2 points) Represent graphically the indifference curves of a typical worker.
Explain the shape of the curves.
b) (2 points) Represent graphically the isoprofit curves. Explain their format and
identify the relevant isoprofit.
c) (2 points) Explain and represent graphically the market equilibrium. Is there any
the compensation wage differential. Justify your answer.

Non-monetary Compensation
Question 1.
Suppose Congress were to mandate that all employers had to offer their employees a
life insurance policy worth at least $50,000 in the event of death. Use economic theory
to analyze the effects of this mandate on employee well-being.

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Labor Economics
Question 2.
Taking into account the theory of compensating wage differentials and the choice
between monetary and non-monetary compensation, read the following article:
Nearly 800,000 Portuguese have health insurance paid by firms
PPR (pension plans) are also a way to reward workers
Firms are increasingly focusing on other components of remuneration besides the
wage. Health insurances are a good example. At this time, there are about 660-800
thousand Portuguese who benefit from these insurance paid by the employer. (...)
People are aware that their income is not just wage, but also and increasingly
protection in health and social security (like pension plans)
Source: www.agenciafinanceira.iol.pt; January 27, 2009
a) Represent graphically the indifference curves of two individuals with different
preferences regarding the choice between wages and non-monetary benefits.
Justify.
b) Suppose that a firms isoprofit has a constant slope that is equal to -2. Represent
graphically the isoprofit and interpret the slope.
c) Explain and represent graphically the market equilibrium assuming that the
previous firm is representative of the market.
d) Assume that a firm decided to substitute the payment of health insurance for a
pension plan (PPR). What can explain this change in the firms policy and what
is the likely impact on the slope of the isoprofit.

Question 3.
Choose the one alternative that BEST completes the statement or answers the question:
1. Workers indifference curves for wage rates versus benefits will be:
(a) downward sloping.
(b) upward sloping.
(c) downward sloping and concave.
(d) upward sloping and convex.
2. Introduction of a benefit that turns out to decrease productivity would cause a
firms iso-profit curve to
(a) flatten.
(b) become steeper.
(c) remain unchanged.
(d) become convex.
3. High-paying jobs are also associated with generous benefits because
(a) benefits which cost $100 generally increase utility by more than $100 in
cash.
(b) high-paid workers can benefit from the tax advantages given to benefits.
(c) employers know how to spend money better than their employees.
(d) high-paid workers are risk neutral

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Labor Economics
4. A firm offers the optimal mix of wages and benefits. It is paying $5 an hour in
wages and $3 in benefits. The minimum wage is then increased from $5 to $7 an
hour. Assume all workers have the same utility curves (and have the usual
shape). If the firm continues to spend $8 an hour on workers, then
(a) workers will be better off
(b) workers will be as well off as before.
(c) workers will be worse off.
(d) it is impossible to determine if workers are better or worse off without
knowing if benefits are a normal or inferior good.

Question 4.
Classify the following statements as true or false, always briefly justifying your
answer:
1. (1 point) The introduction of a health insurance (non-monetary remuneration)
may increase the slope of firms iso-profit.
2. (1 point) In the presence of progressive taxes, individuals prefer the nonmonetary compensation to monetary compensation.

Question 5.
What is the importance of the tax factor in the choice between monetary remuneration
and non-monetary remuneration?

Variable pay
Question 1.
Consider a worker that produces shirts. If his compensation was not affected the worker
would prefer to work at an easy pace. The worker views his cost per hour (C) of
producing shirts (S) as given by:
C = a Sb
The firm is considering the payment of a piece rate, i.e., a certain amount per shirt. The
workers compensation (W) is given by:

W S
A shirt sells for 20a (to simplify, suppose there are no other costs of shirt producing).
a) Discuss reasonable values for the parameter b. Justify.
For the following questions suppose that b=2

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Labor Economics
b) Graph and interpret the function C.
c) Graph and interpret the workers supply of shirts.
d) How many shirts does each worker produce? What is the optimal
compensation policy?
e) What is the level of profit per worker per hour?

Question 2.
From May to July, Florinda works in cherry picking at the firm Cerejovski, Inc. Her job
is to pick cherries and put them in baskets. The cost (C) associated with the effort
required in this activity is given by:
1
C X2
2
The firm Cerejovski, Inc decided to pay its workers based on the number of baskets of
cherries harvested, i.e.:
W X
Each basket of cherries is sold in the Cherry Cooperative for 5. Besides the wage costs
(W) the only additional cost to the firm is the price of the baskets which is 1 euro per
unity.
a) How many baskets of cherries will Florinda fill per hour? What is the optimal
remuneration policy for the firm Cerejovski, Inc?
b) Assuming that the firm hired 10 workers identical to Florinda in all
characteristics and that work 6 hours per day, which is the firms daily profit?
c) The firm is considering changing its remuneration policy to paying a fixed
hourly wage to their workers. Discuss the advantages and disadvantages of each
of the remuneration systems. Which system seems most suitable for the firm?

Question 3.
Firm ABC, Inc. chose to pay their workers according to the quantity produced per hour,
that is:
W X.
The cost associated with the effort required in this activity is given by:
C(X) aX 2
Where X is the quantity produced per hour.
The Human Resources Department concluded that the optimal remuneration is as
follows:
W 1 X
a) Given that the optimal quantity produced per hour is 2 units, determine the
parameter a.
b) Interpret the parameter . Compare this result with the strategies that companies
adopt in practice.

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Labor Economics
c) Interpret the parameter . Compare this result with the strategies that
companies adopt in practice.

Question 4.
John is a bookseller at the firm Crculo de Leitores and works on commission. He
faces a daily cost (C) associated with the sale of each book (L) given by:
C = 1/2 L2
Johns wage (W) depends on the number of books sold according to the following
relation:
W = + L
The average selling price of books is 15 and there are other non-wage costs associated
with firms operation in the amount of 10 per book.
a) Determine the number of books sold by John, the remuneration policy and the
optimal profit per employee for the firm Crculo de Leitores. Justify your
answer.
b) Explain why, usually, commissions are based on sales and determine its value.
Justify.

Question 5.
Choose the one alternative that BEST completes the statement or answers the question:
1. One problem with pay for performance is that
(a) it provides incentives for workers to put forth effort.
(b) workers are risk-averse.
(c) supervision is very expensive.
(d) workers are income maximizers.
2. Pay for performance works LEAST well for an employee
(a) who works as a counselor for other employees in a company.
(b) who is closely supervised.
(c) who maximizes utility.
(d) whose value added is easily measured.
3. Which of the following types of pay is NOT linked to output?
(a) commissions
(b) profit sharing
(c) hourly wages
(d) piece-rate pay

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Labor Economics

4. Many employees prefer to be paid on the basis of

(a) output, because it decreases variation of wages.
(b) time, because it decreases variation of wages.
(c) output, because it increases variation of wages.
(d) time, because it increases variation of wages.
5. The workers who will prefer piece-rate pay will usually be
(a) less present-oriented than average.
(b) less motivated than average.
(c) more productive than average.
(d) more risk-averse than average.
6. Workers who are paid on a piece-rate basis tend to
(a) work quickly.
(b) have a high regard for quality.
(c) require close supervision.
(d) work well as members of a team.

Question 6.
Classify the following statement as true or false, justifying your answer: It is preferable
for workers that the commissions are based on the sales and not on the profits.

Question 7.
Discuss in what circumstances the firms should opt by a variable remuneration and in
which situations it is preferable to opt for a fixed remuneration.

Question 8.
Carefully read the text
No variable pay for TCS trainees during training period
Tata Consultancy Services (TCS), Indias top software exporter has announced that
fresh recruits will not be eligible for variable pay during their training period of six
months.()
Ajoy Mukherjee, Vice President and Head of Global Human Resources of TCS, has said
that the compensation re-structuring is primarily from a productivity point of view.()
Source: www.topnews.in; September 17, 2009
a) Identify the type of compensation referenced in the text and discuss the
advantages and disadvantages of this type of incentive system.
b) Taking as a framework the theory on who should pay for the training comment
the text above. Discuss the policy implemented by TCS giving particular
emphasis to the argument outlined at the end of the text. Illustrate graphically
and justify your answer.
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Labor Economics

Promotions
Question 1.
The firm Soft, SA produces computer software. The administration intends to build a
hierarchy of functions that allow their employees to progress in their careers within the
company (internal labor market). Nowadays, the human resources department is
studying the wages of two professional categories: technician and supervisor.
()
Supervisor W1 = ?
Technician

W2 = ?

()
Figure 1: Excerpt from the job ladder firm Soft, SA
Assessing the relative performance of employees at end of period, the administration
will promote the individual that is more productive.
The average selling price of the firms product is 5 m.u. and the quantity produced by
each individual is given by:
q
q quantity;
effort
- luck: random factors that the worker cannot control.
At the moment there are two candidates to the post of supervisor: John (j) and Carla (k)
and it is known that, for both, the cost associated with effort is given by:
C( ) 2
1
It is known that the random variable k j uniformly takes values between and
2
1
.
2
a) The human resources department is considering the following hypotheses:
Hypothesis 1: Supervisor W1 = 9 m.u.
Technical W2 = 3 m.u.
Hypothesis 2: Supervisor W1 = 12 m.u.
Technical W2 = 6 m.u.
For each of the hypothesis considered, compute:
1. The expected output per woker.
2. The profit of the firm.
b) Answer to the above questions again assuming that the average price of the
firms product increases to 6 m.u.
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Labor Economics
c) Both tournaments and piece-rates are strategies used by firms to motivate and
encourage the efforts of workers. Discuss under which circumstances the
tournaments are preferable to piece-rates.

Question 2.
The firm ABC Ltd. is deciding the wages of two professional categories: chief (W1) and
commissioner (W2). Assessing the relative performance of the employees, at end of
period, the firms management will promote to chief the most productive individual.
The firm has two candidates, workers j and k, and it is known that for both the cost
associated with effort is given by:
C( ) 2 2
The final price of the firms product is 2 m.u. and the output per individual is given by:
q 2
q quantity;
effort;
- luck: random factors that the worker cannot control.
1
1
It is known that the random variable k j uniformly takes values between and .
8
8

a) Determine the expected output per worker, the premium and the wage rate that
has to be paid to each of the occupational categories.
b) Compute the firms profit.
c) Suppose now that the random variable is taking values uniformly between -1
and 1. Without doing any further calculations, explain what will happen to
the premium paid by the firm.

Question 3.
John (j) and Carla (k) compete to a promotion at firm Soft, SA. Assessing the relative
performance of employees at end of period, the firms management will promote the
most productive individual.. The promoted employee will earn a wage of W1 while the
other will receive only W2 .
The average selling price of the firms product is 6 and the quantity produced by each
worker is given by:
q = 2u +
where q is the quantity, u is the level of effort and is a random variable that represents
luck, that is, random factors that the worker cannot control.
The effort cost for each worker is given by:
C(u) = 2u2
Suppose that the random variable (k- j) can assume one of the following structures:
[A] Uniform distribution, taking values between -1 and 1;
[B] Uniform distribution, taking values between - and .

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Labor Economics
a) In which of the hypothesis to the shape of the density probability function of the
variable luck, [A] or [B], one can conclude that it will have a higher importance
in the outcome of the tournament? Justify.
To answer to b) and c) assume the hypothesis [B] as the sturcture for luck:
b) Determine and represent graphically the effort supply function of each worker.
c) Determine the optimal wage strategy, the optimal level of effort and the total
profit of the firm.
d) Without doing calculations, explain what would happen to the value of the
premium and to the average wage level paid by the firm if we assumed the
hypothesis [A] as the structure for luck.

Question 4.
In the promotion model, the tournaments winner is determined by the effort expended
by workers but also by luck, or by other random factors beyond the control of
individuals."
Discuss the excerpt explaining how the importance of luck affects the average wage
paid by firms.

Question 5.
Carefully read the text:
A university degree is almost essential for entering the aerospace industry particularly for science or engineering roles. Diploma qualifications may secure
apprenticeship positions, but pathways up the job ladder for these candidates will be
slower and limited compared with university graduates.
Source: www.aerospace-technology.com
Identify the type of incentive referenced in the text and discuss the advantages and
disadvantages of this type of incentive system.

Question 6.
Considering the promotion model presented in classes, discuss the impact of the
following scenarios (assuming everything else remains constant) in the premium and in
the density probability function of the variable k j :
a) The luck factor becomes less important;
b) The reservation wage of workers decreases.
Justify your answers.

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Labor Economics
Question 7.
Classify the following statements as true or false, always briefly justifying your
answer:
1. In the tournament model, if workers are heterogeneous the optimal level of
effort will be reduced when compared to the situation in which individuals are
homogeneous
2. In the tournament model, a way to avoid collusion of candidates that can lead to
the reduction of effort is the existence of many candidates to promotion.

Seniority and efficiency wages

Question 1.
100 years ago, Henry Ford announced the five-dollar day, sharply increasing the
price that he was willing to pay for the work in his car company. Although increasing
wages is not usually the first thing we think about when we want to cut costs, Fords
strategy has generated significant savings for his company (...) "
Source: www.fangraphs.com
Discuss the excerpt explaining how Fords strategy has generated significant savings
for his company.

Question 2.
a) Provide a concrete example in which piece-rates are preferable to a
remuneration based on seniority and another example where there the opposite
occurs. Justify.
b) Discuss the following statement: The payment of a wage above productivity
only occurs when productivity depends on the wage, i.e., in the model of
efficiency wages.

Question 3.
Choose the option that BEST completes the statement or answers the question:
1. Suppose a firm has implemented a remuneration system that depends on the seniority
of the employees in the firm. Which of the following statements is true?
a) None of the statements is correct.
b) At an early stage of the employment relationship the firm pays a wage above the
workers marginal productivity and later pays a wage lower than the productivity
to recover the investment made in the employee.
c) This type of compensation attracts workers who are more interested in staying in
the firm for a long period inducing thus adverse selection.
d) Contrary to what happens with a variable compensation system based on output,
in periods of economic recession such remuneration system does not involve any
risks to workers.
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Labor Economics

2. Relatively to the model of efficiency wages, which of the following statements is

correct?
a) The value of the efficiency wage is lower the lower is the unemployment rate in
the economy.
b) All statements are correct.
c) This model allows to justify the existence of voluntary unemployment in
equilibrium.
d) This incentive system is suitable when workers' productivity depends on the
wage.
Question 4.
Classify the following statements as true or false, always briefly justifying your
answer:
1. The existence of segmented labor markets or dual may result from the fact that
only a few firms pay efficiency wages.
2. The remuneration of the type W q is preferable to a remuneration based
on seniority.
3. In the presence of economic recessions, the payment of a remuneration based on
seniority has increased risks for workers.

Question 5.
What are efficiency wages? What is their main goal?

Question 6.
Comment carefully the following statement presenting three examples that support it:
The worker throughout his career, may experience periods where their marginal
productivity differs from the wage.

30