Boal's Econ

ECON 115 - Labor Economics
Drake University, Spring 2017
William M. Boal

EXAM 1 ANSWER KEY

I. Multiple choice

(1)a. (2)b. (3)d. (4)b. (5)c. (6)b. (7)b. (8)b. (9)b. (10)a. (11)b.

II. Problems

(1) [Regression analysis: 6 pts]

ln(W) = 2.95.
Wage increases by about 15 percent.
No, not significant, because estimated coefficient of S is less than twice its standard error. Specifically 0.15/0.10 = 1.5 < 2.

(2) [Measuring the labor force: 8 pts]

(3) [Budget constraint: 6 pts]

(4) [Optimal choice: 8 pts]

The reservation wage equals the MRS at the endowment bundle. MRS = MU_L/MU_C = (C-100)/(L-10). Inserting nonlabor income for C and total available time for L gives reservation wage = $4.
Budget constraint is spending = income, or C = 300 + (60-L) 20 = 1500 - 20 L.
Tangency condition is MRS = wage, or (C-100)/(L-10) = $20. Solve this equation jointly with the budget constraint found in part (b), to get L*= 40 hours, C*= $700.
h*= total available time - L* = 20 hours.

(5) [Individual labor supply - income and substitution effects: 22 pts]

50 hours.
$100.
$10 per hour.
$30 per hour.
income effect: work less. An increase in the wage is like an increase in nonlabor income in that the budget line is now farther from the origin. So the income effect is to "purchase" more leisure and more consumption.
-15 hours.
substitution effect: work more. An increase in the wage is an increase in the price of leisure compared to the price of consumption. So the substitution effect is to "purchase" less leisure and more consumption.
+5 hours.
total effect: work less.
-10 hours.
(w,h) = ($10,40 hours), ($30,30 hours). Amanda's labor supply bends backward.

(6) [SR labor demand: 9 pts]

VMP_E = price of output × MP_E. Set VMP_E = wage, insert given values, and solve to get E* = 200.
Using production function, q* = 160 units of output.
profit = Revenue - Total Cost = $400.

(7) [LR labor demand - scale and substitution effects: 16 pts]

Slope of any isocost line = -w/r, where r = price of capital. The slope of isocost line #1 is -1. We are given that r = $10, so w = $10 on isocost line #1.
Similarly, the slope of isocost line #2 is -4, so w = $40 on isocost line #2.
substitution effect: use less labor.
10 units of labor.
scale effect: use less labor.
20 units of labor.
total effect: use less labor.
30 units of labor.

(8) [Hicks-Marshall rules: 6 pts]

III. Critical thinking

Xavier and Yolanda have the same average income over their lifetimes, so comparing the two, there is no income effect, only a substitution effect. Therefore, when Xavier's wage is less than Yolanda's wage, Xavier will work fewer hours than Yolanda. When Xavier's wage is more than Yolanda's wage, Xavier will work more hours than Yolanda. (Full credit requires a life-cycle graph graph with annual hours of work on the on the vertical axis and age on the horizontal axis. Yolanda's curve should be roughly flat. Xavier's curve should slope upward, intersecting Yolanda's curve in the middle.)
Children are not an inferior good. The total fertility rate has fallen because the "price" of children has increased relative to other goods. The "price" of children is the cost of raising children. It has increased because of the rising cost of health care and college tuition and many other things, but especially because of the rising opportunity cost of mothers' time as women's wages have risen. (Full credit requires an indifference-curve graph with children on one axis and other goods on the other axis. The graph should show inward rotation of the budget line from an increase in the price of children. Tangencies before and after the rotation, indicating choices by typical families, should be marked.)