ECONOMICS 324

D. HAMERMESH

ANSWER KEY FOR PROBLEMS/QUESTIONS ON PARTICIPATION AND HOURS 1. How would you classify the labor-force status of the following, and why? a. My 86-year-old mother, who does 20 hours per week of unpaid volunteer work teaching other older people how to use the Web. Out of the labor force because she is not performing or seeking paid work. b. My eight-year-old grandson, who works 20 hours per week for pay on a paper route. The CPS doesnt collect data for people under age 16, so hed be out of the labor force. c. A guy whose union is out on strike. The CPS classifies striking workers as employed. d. A 61-year-old man who is in a nursing home. Out of the labor force assuming that he is not actively seeking work. e. A 16-year-old who is doing 20 hours per week of unpaid work in his fathers business. Employed because he is 16 or older and, although the work is unpaid, it is for a family business. 2. Let a workers daily utility function be U = U(L, Y) = LY, where L is leisure and Y is income. The worker earns a wage of w per hour, and there are 16 hours available in the day. Her income is Y = I + w[16-L], where I is unearned income, with both I and w taken as given by the worker. For now let I=1000

a. Draw the workers indifference map between leisure and income.

Y 10 The slope of this workers indifference curves is MUL/MUY=-Y/L.

2 2 4 10 L (hours per day)

b. What value of the wage rate w would induce the worker not to participate in the labor force? The workers reservation wage is equal to the marginal rate of substitution at the endowment point of (16, 1000). At this point, MUL/MUY=1000/16=$62.50. So if the wage rate falls below $62.50 per hour, this worker would not supply any hours of labor. c. If the wage rate is $1 per hour, how many hours per day will the worker supply?

d. The wage now rises to $2 per hour. What happens to her hours of work, her leisure and her income? Why dont her hours double?

e. Let I now equal 2000. What happens to hours of work? Why?

3. Draw an indifference map and show how the requirement that workers receive timeand-a-half for overtime affects their desired hours of work. Then draw the budget constraint so that the worker receives the same total income and examine how her supply of hours changes.
This worker has 110 hours available for work or leisure in a week. If he works more than 40 hours (has less than 70 hours of leisure), he is paid time and a half, causing a kink in his budget constraint. In the absence of overtime laws the worker would choose to work 35 hours per week (Point A). However, if overtime is available he can reach a higher level of utility by working 50 hours per week (Point B). So overtime laws cause this worker to increase his labor supply. If instead the worker simply received the same total income as at Point B, then he would choose to locate at Point C, would work fewer hours than under overtime laws, and would be better off than in either of the first two cases.
B C

40w + 70(1.5w)

40w

60

70 75

110

L (hours per week)

4. Draw an indifference map. Then draw the workers equilibrium if she receives unearned income of I and a wage rate of w per hour. Using this as a starting point answer each of the following questions using your graph:
Y I+16w
A

Without government intervention, our worker will choose to a consumption bundle at point A, where she works 10 hours per day.

I 6 16 L (hours per day)

a. How does her labor supply change if the government takes away 50 percent of her I if she works more than 8 of the 16 hours per day?
Y I+16w 0.5I+16w This government policy creates a discontinuity in our workers budget constraint. As a result, she will now choose to work exactly 8 hours per day and will have lower utility than before.

A B

I 6 8 16 L (hours per day)

b. How does her labor supply change if her only choices are working 4 hours, 8 hours or 16 hours per day?
Y I+16w
A B

Now our consumers budget constraint is limited to three points. The best that she can do is to choose to work 8 hours per day at point B.

I 6 8 12 16 L (hours per day)

c. How does her labor supply change if the government imposes a 50 percent tax rate on every dollar she earns?
The effect of this tax is to effectively lower our workers wage by half. As a result, her budget constraint tilts in. In general, whether she works more of less depends on whether the income or substitution effect dominates. As drawn here, the income effect dominates since our worker chooses to move from A to B, increasing her hours of work. L (hours per day)

Y I+16w
A

I+16*0.5w

I 6 16

ECONOMICS 324

PROBLEM SET 2

D. HAMERMESH

ANSWER KEY FOR PROBLEMS/QUESTIONS ON EQUILIBRIUM AND COMPENSATING WAGE DIFFERENTIALS I. Suppose that in a local labor market the labor supply and demand curves are: LS(t) = 50W(t); LD(t) = 800 - 50W(t), where W is the wage, t indicates time. A. What are the equilibrium wage rate and employment in this market? At the equilibrium wage, LS (t ) = LD (t ) 50W (t ) = 800 50W (t ) so w*(t)= $8 L*=400 B. If labor supply doesnt change, what will the unemployment rate be if a $10 minimum wage is imposed on the market? If wmin=$10, then LS(t) = 50*10=500 and LD(t) = 800 -50*10=300, so unemployment will be 200. C. If we remove the minimum wage, but the constant term in the labor-demand equations rises to 1,000 due to an export boom, what happens to employment and wages? At the equilibrium wage, LS (t ) = LD (t ) 50W (t ) = 1000 50W (t ) so w*(t)= $10 L*=500

II. Suppose the market for court reporters is characterized by: LS(t) = W(t-1); LD(t) = 100,000 - W(t), where t-1 denotes the wage one year ago. A. Assuming the wage in 2002 was $60,000, fill in the table below: Year 2003 2004 2005 Number Employed 60,000 40,000 60,000 Wage $40,000 $60,000 $40,000

B. Is there an equilibrium wage in this example? Will it ever be reached? What should a smart potential court reporter do given the strange nature of this market?

There is no long-run equilibrium wage; it oscillates each year from $40,000 to $60,000 and back. A smart potential court reporter might choose to only work in the even years when wages are high or would choose to get trained in a year when the wage is low. That would smooth out the cycle.

III. Suppose one-third of all workers demand an extra 50 percent above the standard wage rate of $20 per hour in order to work in dirty jobs, while two-thirds of the work force is willing to work in dirty jobs at $20 per hour. A. Assume employers demand is independent of the relative wages that must be paid in clean and dirty jobs. How much extra will be paid for dirty work if one-half of the jobs are dirty? How much if three-fourths of the jobs are dirty?
d

L1D

L2D

LS The equilibrium compensating differential, d*, will be $0 if half of the jobs are dirty. If 75% of the jobs are dirty, d* will be $10.

30

20 50 66 75 100 % workers in dirty jobs

B. Now assume that the fraction of dirty jobs employers offer equals 1-d, where d is the fraction by which the wage on dirty jobs exceeds that on clean jobs. What will d be in equilibrium, and what fraction of the work force will work in dirty jobs? Will any workers earn more than their reservation wage? If so, what would you try to do as a smart employer?

LS The equilibrium wage will be somewhere between $20 and $30, with 2/3 of the jobs being dirty. All the dirty workers will make above their reservation wage; you should try to price discriminate.
66 100 % workers in dirty jobs

LD
30

20 1

IV. Suppose that as an employer you wanted to attract each of the following types of workers. How might you design a package of employee benefits to make the desired workers more likely to apply to your firm? A. Workers who will have fewer health insurance claims, thereby lowering your insurance costs. You might make the health insurance deductible high or benefits low so that workers who are likely to have higher medical costs wont apply. B. Workers less likely to sue you. You might require a mandatory arbitration program in the hopes that potential employees who are after a settlement wont want to have to deal with company arbitration. On the other hand, this could backfire and attract conflict-prone employees. C. Workers less likely to change jobs. You might offer increasing benefits with tenure. For instance, you might start with relatively little vacation time, but have rise with tenure so that once an employee has been with your firm for several years, they get more vacation than if they were to change jobs and work elsewhere. Workers who know that they are likely to change jobs would not be attracted to the initially low vacation time, but workers who are likely to stay a while will be more willing to accept the trade-off of having greater vacation later. D. Workers more likely to work weekends. It may be the case that workers with children at home are less likely to be willing to work on weekends. So you might NOT offer good childcare or maternity benefits. Childless workers (or those who dont desire children) wouldnt care, but others would be less likely to work for you. E. Workers who are better informed about current events. You might offer subscriptions to news periodicals as a benefit. Workers who care about reading them (which is presumably positively correlated with being up on current events) will see this as added compensation.

ECONOMICS 324

PROBLEM SET 3

D. HAMERMESH

PROBLEMS/QUESTIONS ON HUMAN CAPITAL AND WAGE STRUCTURES

1. Bob White is a 58-year-old construction worker who earns $16 per hour. While driving his backhoe he hits a gas main that the gas company failed to inform him was present at the construction site. Bob is severely injured and cannot work again. As a consulting economist to Bobs attorney, what is the present value of the lost earnings that you would recommend seeking from the gas company? Aside from his earnings, what else do you need to know to make the calculation? State this, then make the calculation. To make this calculation, you need to know: - Bobs nominal yearly earnings (Ill assume that its $16*(40*52)hours=$33,280) - What age Bob would have retired at (Ill assumed at age 63, so he would have worked 5 more years) - The appropriate discount rate to use (Ill use 0.08). Then, the Net Present Value (NPV) of Bobs lost earnings is:

4 33,280 1 = 33,280 NPV = t t t = 0 1.08 t = 0 1.08

= $143,508
2. Bright people (B) are more productive. For each year of schooling they get, their productivity rises by $2 per hour. Dull people (D) are less productive. For each year of schooling they get their productivity rises by only $1 per hour. The problem is that employers cannot tell Bright and Dull workers apart. All they can see is how much schooling they have obtained. Employers will wind up paying educated workers (those with 16 years of schooling) $36,000 per year, and will pay uneducated workers (12 years of schooling) $24,000. (Theres nothing in between 12 and 16 years of schooling.) Assume that each worker has 35 available years after high school and ignore discounting. a. Under what conditions will a worker choose to go to college?
If a worker doesnt go to college, he gets 35 years * $24,000= $840,000. If a worker does go to college, he gets 31 years* $36,000= $1,116,000. So a worker who goes to college gets $276,000 more over his lifetime. Hence, a worker will choose to go to college if the total cost is less than $276,000.

b. Given your answer in Question 2a, is this model a realistic description of the labor market?
While college is pretty expensive, four years still doesnt generally cost $276,000 (remember, weve already factored in lost earnings). So it seems likely that both types of workers would choose to go to college, which isnt very realistic.

3. Josephine Morgan begins work right after college, earning $30,000. She expects her earnings to rise by $1000 per year each year during her first 10 years of work, by $500

per year each year during the next 10 years, and to stay constant thereafter. Graph the age-earnings profile that she envisions. Assume that the increases happen because, upon her beginning work after college, she spent $50,000 on a training course that occurred instantly when she started the job. What is the rate of return on her investment in training? $30,000 + 1,000t if t 10 yearly earnings = $40,000 + 500t if 10 < t 20 $45,000 if t > 20
Suppose that Josephine plans to work for 30 years. If she had not invested the $50,000, she would have earned 30*$30,000=$900,000 over the course of her career. Because she did invest the $50,000, she will earn $1,262,500. So her $50,000 invest will provide $362,500 to her over the course of 30 years or a total return of 725% you need to discount each year. Using a spreadsheet to do this (or solving the integrals, you can show that her investment yields an average annual return of 7.2 percent.

4. You are the employer in a large firm. You offer workers an hourly wage determined according to: Wage = $10 + .20 x Years with Firm All workers enter the firm at age 25, and nobody quits. Each worker produces output valued at $14 during each hour at work. a. Can your firm survive without inducing workers to retire at some age? If yes, explain why; if no, at what age would you want them to retire, and why?
The MRPL is $14 while the MC of a worker is $10+0.2t. So it is profitable to keep a worker on as long as: 14 10 + 0.2t t 20 . So the firm is losing money on workers who have been there for over 20 years. It would like them to retire at 20 years; but for sure if anyone is expected to stay after 40 years it loses money on them when the wage rises above $18.

b. Assume you wish to induce the workers to retire. Assume also that workers value their leisure at $12 per hour and that all workers in the firm put in 2000 hours per year. Construct a pension scheme that will suffice to get workers to retire voluntarily at the age you want them to leave.
So, lets say that you want to induce workers to retire voluntarily when they turn 66. Rather than keeping them on and paying them $18 that year, you offer to retire them with a pension of $6. You could pay for this with the gains that you get from younger workers (youre paying all of them less than they are worth) and this is cheaper than paying the older workers $18+ an hour. Since the wage would rise from $18 thereafter, it is necessary to increase the pension by $.20 per hour each year, so that the value of leisure plus the pension equals the wage they would get if they hadnt retired.

5. List all the jobs you have held (all the different employers for whom you have worked) since you first participated in the labor force. How does this compare to the information for the entire U.S. labor force presented in class?
Our TA has held 6 jobs by the time she is 27. That is about on target for the average American. Your prof has held 9 jobs up through his current age of 61. This is also about average.

6. Your workers efforts depend to some extent on their wages. In particular, a workers daily MP = 50 + 5W, where W is the hourly wage, and you sell output for $1 per unit. Each worker works 8 hours per day. a. What is the most you would pay a worker if you pay a fixed amount per hour?
The most you can get from a worker in a day is $1(50+5w), so you will be willing to pay the worker as long as he costs less than hes making you: 50 + 5w 8w w $16.67 . So the most that youd be willing to pay per hour is $16.67

b. A workers daily output could also be affected if you offer a piece rate system. In particular, a workers daily MP = 2 x PR x H, where PR is the rate of pay per unit of output and H is hours worked per day. Assume again that you sell output for $1 per unit. Your advisor suggests that you offer a piece rate of $5. Would your firm be as productive as in Question a? What if you were to offer a piece rate of $10?

In part a, if you pay $16.67, daily productivity is 133.35. Assuming that each worker still works 8 hours per day (inelastic labor supply), then with a $5 piece rate, daily productivity will be 2x5x8= 80, less than in a. If the piece rate were $10, daily productivity would be 2x10x8=160, more than in a. Note, though, that this is really a pretty bad system. Youll be paying each worker (PR x daily productivity) whereas you only make ($1 x daily productivity). So if you pay a piece rate of anything greater than $1, you make a loss. Furthermore, if you pay $1, productivity is 24, which is much lower than under the system in part a.

ECONOMICS 324

PROBLEM SET 4

D. HAMERMESH

PROBLEMS/QUESTIONS ON MIGRATION AND DISCRIMINATION

1. The following data show annual earnings (in 1000$) of immigrants to the U.S. by age in each of three Census years: Age 1980 25 35 45 $30 50 70 Year 1990 $30 35 55

2000 $25 35 40

a. Calculate the rate of earnings growth (the rate of assimilation) that is suggested by looking at the data from the 1980 Census only. What do your calculations suggest about immigrant assimilation into the U.S. labor market, assuming that native workers earnings grow by 50 percent between ages 25 and 35, and by 1/3 between ages 35 and 45? Looking at data from the 1980 census only, immigrant earnings increase by 60% between ages 25 and 35 and by 40% between ages 35 and 45. If the earnings of native workers grow by 50% and 33% during these respective periods, this suggests that immigrants were catching up with the natives as they acquire U.S. specific skills. b. Calculate the rate of earnings growth (the rate of assimilation) for the cohort of immigrants who were 25 years old in 1980. What do your calculations now tell you about how rapidly immigrants are being assimilated? Why the difference between these results and those in Part a? What does the difference tell you about how the immigrant population is changing? Looking at the cohort of immigrants who were 25 years old in 1980, their earnings grew by 17% between ages 25 and 35 and by 14% between ages 35 and 45. This is slower than in Part a, and slower than natives, suggesting that immigrants are failing to assimilate. That these growth rates are slower than in Part a suggests that the later cohorts are less skilled than earlier cohorts.

2. Most immigrants to the U.S. come here at fairly young ages, but not all do. Discuss ways in which the age at which someone migrates to the U.S. might affect his/her earnings. The earnings of an immigrant once he arrives in the U.S. will depend on his skill level, including skills that might be U.S.-specific. The idea of assimilation is that as immigrants spend time in the U.S. labor market, they will acquire skills that will help them here and help them to catch up with native workers. A young immigrant will have more time for this process

than will an older worker, so all else equal, an older worker will have less time to catch up. Moreover, older workers may have more trouble acquiring language skills or other U.S.-specific skills, making them less likely to assimilate.

3. Assume that Blacks represent 30 percent of the labor force and are equally productive as Whites. Employers i are willing to hire blacks and pay them a wage: WB = WW[1 - di ], where the subscripts B and W refer to Black and White workers. For 10 percent of employers di = -.1; for another 10 percent di = 0; di = +.1, etc., and for the final 10 percent of employers di = +.8. Assume that the number of Black and White workers is fixedboth labor supplies are completely inelastic. a. What is the equilibrium percentage wage difference between Black and White workers? For which employers will Blacks be working? Since labor supply is inelastic, LS = 0.3 . Labor demand, however, depends black on the wage differential. Note that the first 10% of employers will hire w blacks if wB wW 1.1 B 1.1 , the second 10% of employers will hire ww w blacks if B 1 , and so on until the last 10% of employers who will hire ww w blacks if B 0.2 . In equilibrium, the supply of black workers must equal ww the demand of black workers, so 30% of firms must demand black workers. w To get the first 30% of firms to demand black workers, 0.8 < B 0.9 , lets ww say that its 0.9. So in equilibrium, blacks will earn 90% of what whites earn and will work for the least prejudiced 30% of firms (the firms with the highest di).

b. Tired of bigotry by employers, the government launches a policy initiative that involves sensitivity training of the most bigoted employers. How does this affect the wage difference between Blacks and Whites?
If the sensitivity training is for the most bigoted employers, then it presumably wont directly affect the 30% of employers who are least-bigoted and employing blacks. As long as the training doesnt make the formerly bigoted employers so tolerant that their dis fall below .1, there will be no effect at all on the equilibrium outcome.

c. The government now tries a policy of getting those 20 percent of employers who are already most favorable to Blacks to improve their attitudes. How does that affect the wage difference?

This wont affect the wage differential because it depends on the marginal firms that are in the third 10 percent. No matter how sensitive the first 20 percent of firms, the wage differential will still have to be between .8 and .9 to get the last group to hire blacks.

d. The government mandates that all employers must have exactly 30 percent Black in their workforces. How does this affect wage differences? How does this affect economic efficiency?
In this case all firms will have to hire blacks. Since blacks and whites are equally productive and a firm cant offer a lower wage for blacks than another without losing their necessary quota, blacks and whites will earn the same wage. However, this is not efficient since the firms with the highest cost of hiring blacks have to hire them whereas before it was the least prejudiced firms that hired blacks.

4. Discuss the reasons why the earnings ratio between women and men rose from its traditional 60 percent beginning in the late 1970s? Why hasnt the same thing happened to earnings differences between black and white men?
A large portion of the wage gap between men and women can be explained by differences in labor force attachment. Women are much more likely to take extended leaves from the labor force for the purposes of raising a family. However, since the 1960s the amount of time that women spend away from the labor force has been declining, accounting in part for the shrinking male/female wage gap. We havent seen a similar pattern for the white/black wage gap when looking at men because in that case both groups are not very likely to leave the labor force for child rearing.

5. The following equations describe Hispanics and non-Hispanic whites earnings: Log(WH) = 10 + .08YrsSchool + .03Age;

Log(WNHW) = 10.2 + .10YrsSchool + .02Age. The average Yrs of schooling of Hispanics is 11, that of non-Hispanic whites is 13. The average ages of the two groups are 35 and 40. a. What is the percentage difference (difference in logs) in earnings between the two groups?
The average log(wage) for Hispanics is 10+(.08*11) + (.03*35)=11.93 and the average log(wage) for non-Hispanics is 10.2+(.10*13)+(.02*40)=12.3. So, on average Hispanics earn 37 percent less than whites.

b. Adjusting for differences in the average education and age of the two groups, what is the percentage difference (difference in logs) in earnings between the two groups? Comparing this calculation to that in Part a, what do you infer

about the source of earnings differences between Hispanics and non-Hispanic whites, and what do you conclude about the extent of labor-market discrimination against Hispanics?
Lets suppose that Hispanics have the same education level and age as non-Hispanics. Then the average log(wage) for Hispanics is 12.24 and the percentage difference in wages would be only 6 percent. This suggests that a large portion of the Hispanic/non-Hispanic wage gap is the result of differences in characteristics, but that the remaining 6% could be due to discrimination.

ECONOMICS 324

PROBLEM SET 5

D. HAMERMESH

PROBLEMS/QUESTIONS ON UNIONS AND SEARCH

1. Worldwide Wickets sells wires for $5 per unit. Assume it does not need to worry about the cost of its capital equipment. Its output is described as: Workers 1 2 3 4 5 6 7 8 9 10 Total Revenue $50 95 135 170 200 225 245 260 270 275
MRPL ARPL Total Wage Bill $50 90 120 140 150 150 140 120 90 50

$50 45 40 35 30 25 20 15 10 5

$50 47.50 45 42.50 40 37.50 35 32.50 30 27.50

a. What wage will its union set to maximize the wage bill?
For any wage set by the union, the firm will demand labor to the point where the wage equals the marginal revenue product of labor. On the chart above, I filled in the MRPL and the total wage bill (workers*wage=workers*MRPL). The total wage bill is maximized when the union sets the wage at $25 or $30, with employment equaling 6 or 5.

b. What wage will its union sent to maximize the total rents earned by its members if they can earn $20 per hour in nonunion jobs?
Total rents are the total wage bill at the unionized firm minus what those workers would have earned elsewhere. So rents=workers*(MRPL-20) and are again maximized when the wage is $35 or $40, with employment equaling 4 or 3.

c. What is the range of outcomes over which the union can bargain with WW about both wages and employment, subject to the restriction that the firm not lose money?
If the union can bargain over both wages and employment, then at any level employment they could demand wages up to the average revenue product of labor without the firm losing money. I have also filled in the ARPL on the above table. The union could bargain for a wage/employment package of $27.50 and 10 workers to $50 and one worker.

2. Wild n Wooly Beverages bargains with the United American Whiskymakers over wages. WWB offers a $10 per hour raise initially, while the UAW asks for $20. WWB values the gains from bargaining as 10-W, while the UAW values the gains as W.5, where W is the wage increase in excess of $10 that is obtained by the union. (W is between $0 and $10.) Does their bargaining result in a solution that splits the difference in terms of each partys valuation of the gains? Does it produce the solution that W = $5? If yes, why; if no, why not?
The bargaining produces a solution where the product of the parties valuations of the gains from bargaining is at a maximum. This product is: Z = [10-W]*W.5 Z reaches its maximum when W= 3.333. (This can be seen either by graphing Z as a function of W or, more easily, differentiating Z with respect to W, setting the result equal to 0 and solving for W). The bargaining does produce the split the difference solution in terms of how each party values its gains. The union gets most of its satisfaction from the initial increase in W beyond 0; its marginal satisfaction decreases as W increases. Managements marginal satisfaction is constant as W changes. The solution is NOT W=5, because the parties satisfaction is jointly maximized before W reaches 5 due to the nonlinearity of the unions valuation of its gains.

3. Suppose you are given the following information on the number of possible contacts with employers than an unemployed worker may make in a week. How many contacts should she make, and why? Contacts Benefit from Another Contact $15 12 10 9 8 7 Cost of Making Another Contact $3 7 9 12 13 14

1 2 3 4 5 6

She should make 3 contacts, as the third is the last for which the marginal benefit exceeds the marginal cost.