ECON 115 - Labor Economics
Drake University, Spring 2019
William M. Boal

EXAM 2 ANSWER KEY

Version A

I. Multiple choice

(1)b. (2)b. (3)b. (4)c. (5)c. (6)b. (7)b. (8)b. (9)b. (10)b. (11)c. (12)b. (13)b.

II. Problems

(1) [Mandated benefits: 16 pts]

  1. demand.
  2. New demand curve is $3 below old demand curve. Employers are $3 less willing to pay for workers because of the cost of the mandated benefit.
  3. 50 million.
  4. $13.
  5. supply.
  6. New supply curve is $1.50 below old supply curve. Workers are willing to work for $1.50 less because they value the mandated benefit.
  7. 55 million.
  8. $12.50.

(2) [Monopsony: 18 pts]

  1. Set supply equation w=VMP and solve to get E=240.
  2. MLC = 4 + 2E/20.
  3. Set VMP=MLC and solve to get E=180.
  4. Substitute E=180 into labor supply equation to get w=$13.
  5. The minimum wage ($15) is greater than the monopsonist employer's profit-maximizing wage, but less than the competitive wage ($16). So the outcome is on the supply curve. Substituting the minimum wage into the labor supply equation gives E=220.

(3) [Gains from migration: 12 pts]

  1. WN = $16 thousand, WS = $7 thousand.
  2. Workers will migrate until wages are equal, so set WN = WS. Then substitute labor demand equations, and solve to get EN = 70 million, ES = 10 million, and WN = WS = $13 thousand.
  3. Increase in efficiency = increase in value of output in North less decrease in value of output in South
    = [(16+13)/2 thousand × (70-40) million] - [(13+7)/2 thousand × (40-10) million] = $135 billion.

(4) [Immigration: 4 pts]
19791982DifferenceDID
Average wage of African-Americans in Miami $4.90$4.39-$0.51-$0.34
Average wage of African-Americans in other cities $5.70$5.53-0.27

Conclusion: The average wage of African-American workers in Miami was reduced by $0.34 due to the Mariel Boatlift.

(5) [VSL, safety regulation: 12 pts]

  1. VSL = Δ earnings / Δ risk = 943 / (1/10,000) = $9.43 million.
  2. Cost per statistical life saved = cost / reduction in death rate = $1 million / (1.3-1.1) = $5.0 million.
  3. Yes, the system should be required becasuse VSL > cost per statistical life saved.

(6) [Compensating differential with heterogeneous preferences: 8 pts]

  1. If workers do not care in which industry they work, then competition will force the wages to be equal:
    WC = WD
    24 - 0.1 ED = 18 - 0.1 (100-ED).
    Solve to get ED=80, EC=20, WD=WC=$16.
  2. If workers required a compensating differential to work in the Dirty industry, then we have:
    WD - WC = 0.2 ED
    (24 -0.1 ED) - (18 - 0.1 (100-ED)) = 0.2 ED.
    Solve to get ED=40, EC=60, WD=$20, WC=$12.

(7) [Simple model of schooling decision: 10 pts]

  1. NPV "no college" = 100,000 + (100,000/1.05) = $195,238.
  2. NPV "college" = -50,000 + (260,500/1.05) = $198,095.
  3. Chooses "college" because NPV is larger.
  4. Set 100,000 + 100,000/(1+r) = -50 + 260,500/(1+r) and solve to get r*=7 percent.
  5. Chooses "no college" because the benefits from "college" lie entirely in the future. As r increases, then NPV of "college" falls more than NPV of "no college."

(8) [Who pays for OJT: 16 pts]

  1. If training is general, the worker's productivity rises at all employers. Since worker's VMP rises to $35,000 in the second year as a result of training, many other employers are willing to pay the worker a wage of $35,000, so this employer must also pay the worker a wage = $35,000 in the second year. Since the worker enjoys the returns from training, the worker must pay the cost, $5000. So the wage is reduced by the cost of training to $25,000 in the first year. Effectively, the worker pays for training and enjoys the entire return.
  2. If training is specific to a particular employer, the value of the investment will disappear if the worker leaves the firm in the second year. To give the worker an incentive to stay and the employer an incentive not to fire the worker in the second year, both parties must share the returns from training. If they share the returns, competition in the labor market forces the parties also to share the costs of training. Suppose worker pays X in training cost. Then the wage in the first year is $30,000-X. For example, letting X=$3000, the worker's wage in the first year might be $27,000. But if the competitive wage is $30,000, then the average of the first and second year wages must be $30,000. This implies that the wage in the second year must be $30,000+X. Continuing the example, the wage in the second year might be $33,000. Effectively, training is a shared investment, with both sides paying part of the cost and enjoying part of the return.

III. Critical thinking

(1) Adam Smith quote

  1. Adam Smith anticipated the theory of human capital.
  2. Workers earn higher wages if their occupation is more expensive to learn, because otherwise they would not spend the time and money to learn that occupation.

(2) Workers at a restaurant

  1. A restaurant might provide training on basic principles of customer service, on standard cooking techniques, and on standard drink recipes. This training is general because it raises the worker's productivity at other restaurants.
  2. A restaurant might also provide training on the particular restaurant's greetings and place settings, on recipes and portion sizes for the restaurant's menu, and on the restaurant's ordering procedures. This training is specfic because it is useful only at this restaurant.

Version B

I. Multiple choice

(1)d. (2)a. (3)d. (4)d. (5)d. (6)e. (7)a. (8)c. (9)c. (10)a. (11)b. (12)c. (13)c.

II. Problems

(1) [Mandated benefits: 16 pts]

  1. demand.
  2. New demand curve is $3 below old demand curve. Employers are $3 less willing to pay for workers because of the cost of the mandated benefit.
  3. 60 million.
  4. $14.
  5. supply.
  6. New supply curve is $1.50 below old supply curve. Workers are willing to work for $1.50 less because they value the mandated benefit.
  7. 65 million.
  8. $13.50.

(2) [Monopsony: 18 pts]

  1. Set supply equation w=VMP and solve to get E=300.
  2. MLC = -10 + 2E/20.
  3. Set VMP=MLC and solve to get E=200.
  4. Substitute E=180 into labor supply equation to get w=$10.
  5. The minimum wage ($15) is greater than the monopsonist employer's profit-maximizing wage, but less than the competitive wage ($20). So the outcome is on the supply curve. Substituting the minimum wage into the labor supply equation gives E=250.

(3) [Gains from migration: 12 pts]

  1. WN = $22 thousand, WS = $16 thousand.
  2. Workers will migrate until wages are equal, so set WN = WS. Then substitute labor demand equations, and solve to get EN = 60 million, ES = 20 million, and WN = WS = $18 thousand.
  3. Increase in efficiency = increase in value of output in North less decrease in value of output in South
    = [(22+18)/2 thousand × (60-40) million] - [(18+16)/2 thousand × (40-20) million] = $60 billion.

(4) [Immigration: 4 pts]
19791982DifferenceDID
Average wage of Hispanics in Miami $4.57$4.62+$0.05+$0.26
Average wage of Hispanics in other cities $5.21$5.00-0.21

Conclusion: The average wage of Hispanic workers in Miami was increased by $0.26 due to the Mariel Boatlift--certainly a surprising result given the large supply shift.

(5) [VSL, safety regulation: 12 pts]

  1. VSL = Δ earnings / Δ risk = 625 / (1/10,000) = $6.25 million.
  2. Cost per statistical life saved = cost / reduction in death rate = $3 million / (1.3-1.2) = $30.0 million.
  3. No, the system should not be required becasuse VSL < cost per statistical life saved.

(6) [Compensating differential with heterogeneous preferences: 8 pts]

  1. If workers do not care in which industry they work, then competition will force the wages to be equal:
    WC = WD
    20 - 0.1 ED = 18 - 0.1 (100-ED).
    Solve to get ED=60, EC=40, WD=WC=$14.
  2. If workers required a compensating differential to work in the Dirty industry, then we have:
    WD - WC = 0.2 ED
    (20 -0.1 ED) - (18 - 0.1 (100-ED)) = 0.2 ED.
    Solve to get ED=30, EC=70, WD=$17, WC=$11.

(7) [Simple model of schooling decision: 10 pts]

  1. NPV "no college" = 100,000 + (100,000/1.10) = $190,909.
  2. NPV "college" = -50,000 + (262,000/1.05) = $188,182.
  3. Chooses "no college" because NPV is larger.
  4. Set 100,000 + 100,000/(1+r) = -50 + 262,000/(1+r) and solve to get r*=8 percent.
  5. Chooses "college" because the benefits from "college" lie entirely in the future. As r decreases, then NPV of "college" rises more than NPV of "no college."

(8) [Who pays for OJT: 16 pts]

  1. If training is specific to a particular employer, the value of the investment will disappear if the worker leaves the firm in the second year. To give the worker an incentive to stay and the employer an incentive not to fire the worker in the second year, both parties must share the returns from training. If they share the returns, competition in the labor market forces the parties also to share the costs of training. Suppose worker pays X in training cost. Then the wage in the first year is $40,000-X. For example, letting X=$3000, the worker's wage in the first year might be $37,000. But if the competitive wage is $40,000, then the average of the first and second year wages must be $40,000. This implies that the wage in the second year must be $40,000+X. Continuing the example, the wage in the second year might be $43,000. Effectively, training is a shared investment, with both sides paying part of the cost and enjoying part of the return.
  2. If training is general, the worker's productivity rises at all employers. Since worker's VMP rises to $45,000 in the second year as a result of training, many other employers are willing to pay the worker a wage of $45,000, so this employer must also pay the worker a wage = $45,000 in the second year. Since the worker enjoys the returns from training, the worker must pay the cost, $5000. So the wage is reduced by the cost of training to $35,000 in the first year. Effectively, the worker pays for training and enjoys the entire return.

III. Critical thinking

Same as Version A.

[end of answer key]