EC3337: LABOUR ECONOMICS

SECTION A Answer only TEN (10) of the FOURTEEN (14) questions in Section A. These are multiple-choice questions so answer by choosing one letter.

1. The government of Atlantis offers £5, 000 of benefits to those citizens that are not working. For each individual, these benefits are reduced by £1 for each £1 earned in the labour market, until there are no benefits to be paid. Suppose that this benefit programme is then modified so that now benefits are reduced by only £0.6 for each £1 earned in the labour market. Under the old programme, Marla’s total income was £8, 000. If she is in the range to receive benefits, what will be the effect of the new programme on Marla’s optimal hours of work?

a. Both her income and substitution effect will decrease her optimal hours of work.

b. Her income effect will increase her optimal hours of work, but her substitution effect will decrease her optimal hours of work.

c. Her income effect will decrease her optimal hours of work, but her substitution effect will increase her optimal hours of work.

d. All of these are possible outcomes and there is not enough information given in the question to tell what will happen to her optimal hours of work. (4 Marks)

2. Suppose a government offers to pay £65, 000 to workers who become disabled due to a workplace accident. The government agrees to make this payment regardless of a worker’s earnings before the accident. Such a payment scheme would

a. result in only an income effect.

b. result in only a substitution effect.

c. result in income and substitution effects that reinforce each other.

d. result in income and substitution effects that counteract each other. (4 Marks)

3. Consider a firm which has a monopoly on the sale of its goods. The firm faces an inverse demand curve given by P = 20 − 0.2Q, where P is the price per unit of good and Q is the quantity of goods sold. The firm is the only employer in town and faces an hourly supply of labour given by w = E + 32, where w is the hourly wage rate and E is the number of workers hired each hour. Each worker produces 10 units of goods per hour. How many workers should this firm hire in order to maximize its profit? What wage will it pay? How much will it charge for each good?

a. E = 12,w = £30 and P = £30

b. E = 4,w = £36 and P = £12

c. E = 6,w = £34 and P = £24

d. E = 8,w = £28 and P = £26 (4 Marks)

4. Which statement below is correct?

a. A non-discriminating monopsonist hires fewer workers than a perfectly discriminating monopsonist but more workers than a perfectly competitive firm.

b. A perfectly discriminating monopsonist hires the same number of workers as a perfectly competitive firm and each worker gets paid a wage less than his/her reservation wage.

c. A non-discriminating monopsonist hires fewer workers than a perfectly competitive firm.

d. A perfectly discriminating monopsonist hires more workers than a perfectly competitive firm and each worker gets paid his/her reservation wage. (4 Marks)

5. Compared to the labour market outcome when there are no payroll taxes, imposing a payroll tax on labour will typically result in

a. a decrease in overall employment.

b. an increase in deadweight loss.

c. firms paying a higher wage.

d. workers receiving a lower wage net of taxes.

e. All of these are possible outcomes. (4 Marks)

6. Giddy has 13 years of schooling and Biddy has 14 years of schooling. Giddy’s wage is w = £40, 000 and Biddy’s wage is w = £50, 000. They both face the same discount rate r. Given this information, which statement below is correct?

a. Their marginal rate of return to schooling (MRR) is 25 percent.

b. The wage difference between Giddy and Biddy identifies the marginal rate of return to schooling.

c. The MRR of Giddy at 13 years is smaller than the MRR of Biddy at 13 years.

d. Giddy’s MRR at 13 years is larger than her discount rate r. (4 Marks)

7. Anya has 13 years of schooling and Matthew has 14 years of schooling. Anyas wage is w = £40, 000 and Matthews wage is w = £50, 000. They both face the same wage-schooling locus. Given this information, which statement below is NOT correct?

a. Anya’s discount rate (r) must be larger than Matthew’s discount rate (r).

b. For both Anya and Matthew, the marginal rate of return to schooling (MRR) at 13 years is 25 percent.

c. Matthew’s discount rate must be smaller than 25 percent.

d. Anya’s discount rate must be smaller than 25 percent. (4 Marks)

8. If labour supply is perfectly inelastic, the imposition of a payroll tax legislated to be paid by firms will do all of the following except

a. generate tax revenue paid to the government.

b. reduce total output.

c. leave employment levels unchanged.

d. reduce the wage rate by exactly the amount of the tax.

e. leave firm profits unchanged. (4 Marks)

9. Consider a firm’s isoprofit curve (with wages on the y-axis and risk of injury on the x-axis). If Firm A’s isoprofit curve is more steeply sloped than firm B’s isoprofit curve, then this indicates

a. Firm A’s work environment is more dangerous than Firm B.

b. Compared to Firm B, it would be more expensive to increase safety in the workplace of Firm A. c. The wages of all workers in Firm A have to be higher than the wages of all workers in Firm B.

d. Regardless of the costs, both firms will choose to provide the safest environment possible for their workers. (4 Marks)

10. Which statement below is not consistent with the theory of compensating differentials?

a. Workers with poor conditions will always earn more than those with good conditions.

b. Holding worker characteristics constant, workers with poor conditions will earn more.

c. Holding wages constant, higher skilled workers will work under better conditions.

d. All of the above are consistent with the theory of compensating wage differentials. (4 Marks)

11. Consider two firms, Firm A and Firm B. Firm A’s workers face a very high risk of injury at the workplace. Firm B’s workers face a very low risk of injury at the workplace. The workers in the two firms are identical. In other words, workers in Firm A and workers in Firm B are the same in terms of their education, productivity as well as all other characteristics. If a worker in Firm A is paid an extra £10 relative to a worker in Firm B, then this means

a. the value of working at Firm B is at least £10 per hour to all workers.

b. the value of working at Firm B is at least £10 per hour to some workers.

c. the value of working at Firm B is more than £10 per hour to all workers.

d. the value of working at Firm B is £10 per hour to all workers. (4 Marks)

12. Which statement below is correct?

a. When immigrants and natives are perfect complements, immigrant flow to a country shifts the labour demand curve for native workers to the left in the short-run.

b. When immigrants and natives are perfect substitutes, labour demand curve shifts to the right in the short-run.

c. When immigrants and natives are perfect substitutes, labour demand curve shifts to the right in the long-run.

d. When immigrants and natives are perfect complements, immigrant flow to a country decreases the marginal product of native workers in the short-run. (4 Marks)

13. Ben has three years of university, Victoria has two, and Tanya has one. Ben earns £24 per hour, Victoria earns £20, and Tanya earns £16. The difference in their educational attainment is due completely to different discount rates. Given this available information, which statement below is correct about their discount rates?

a. Tanya’s discount rate (r) is smaller than 20 percent.

b. Ben’s discount rate (r) is between 20 percent and 25 percent

c. Victoria’s discount rate (r) is between 20 percent and 25 percent

d. Tanya’s discount rate (r) is larger than 30 percent. (4 Marks)

14. Suppose an economy exhibits general conditions of downward-sloping labour demand, upward-sloping supplies of domestic and immigrant labour, and a competitive labor market. Which of the following is not a likely outcome of immigration?

a. Output produced in the destination country will not change.

b. The market-clearing wage will fall.

c. Some economic surplus will transfer from domestic workers to domestic firms.

d. Economic surplus will increase in the destination country, even net of immigrant earnings.

e. Domestic workers will experience some job losses. (4 Marks)

SECTION B Answer ALL the questions in Section B. Concise and clear answers will be rewarded.

1. Minish has preferences given by the formula U = CL. Assume the hourly wage is w = £4 and that the maximum time available per month is 400 hours. Also assume initially that she has no non-labour income.

a. Consider a welfare programme where the government offers £500 of benefits to those individuals that are not working. These benefits are reduced by £0.5 for each £1 earned in the labour market. Find Minish’s optimal hours of work under this welfare programme. (8 Marks)

b. Consider another welfare programme where the government offers £500 of benefits to those individuals that are not working. But this time these benefits are not reduced at all when individuals earn labour income (i.e. benefits are reduced by 0 percent for each £1 earned in the labour market). Find Minish’s optimal hours of work under this welfare programme. (8 Marks)

c. Which welfare programme provides the least work disincentive? Explain why this happens. (4 Marks)

SECTION B Answer ALL the questions in Section B. Concise and clear answers will be rewarded.

1. Minish has preferences given by the formula U = CL. Assume the hourly wage is w = £4 and that the maximum time available per month is 400 hours. Also assume initially that she has no non-labour income.

a. Consider a welfare programme where the government offers £500 of benefits to those individuals that are not working. These benefits are reduced by £0.5 for each £1 earned in the labour market. Find Minish’s optimal hours of work under this welfare programme. (8 Marks)

b. Consider another welfare programme where the government offers £500 of benefits to those individuals that are not working. But this time these benefits are not reduced at all when individuals earn labour income (i.e. benefits are reduced by 0 percent for each £1 earned in the labour market). Find Minish’s optimal hours of work under this welfare programme. (8 Marks)

c. Which welfare programme provides the least work disincentive? Explain why this happens. (4 Marks)

SECTION C Answer only TWO (2) of the FIVE (5) questions in Section C. For each question you answer, provide an explanation of your answer (3-5 sentences will suffice). Concise and clear answers will be rewarded.

1. Suppose the cost of education is inversely related to ability. In other words, the higher a person’s ability, the lower his/her cost of acquiring any education level will be. Also assume that ability is positively related to productivity on the job. In other words, the higher a person’s ability, the higher amount of output he/she can produce in a job. Lastly, suppose that firms do not have information on worker ability. Consider the following statement: “Based on the above, we can conclude that firms can use educational attainment a screening device (i.e. as a signal to use in order to be able to tell apart high productivity workers from low productivity workers).” Is this statement true or false? Explain why. (10 Marks)

2. How does the total surplus (producer plus worker surplus) in equilibrium for a non-discriminating monopsonist compare to the total surplus in a perfectly competitive market equilibrium? Explain. (10 Marks)

3. Suppose that in a country called Nerdestan, payroll taxes are 60 percent and are legislated to be paid all by firms. However, after the last elections, the Conservative Party takes over the government and reduces the payroll taxes by half. Assuming that labour demand is very elastic and labour supply is very inelastic, answer the following: After the reduction of payroll taxes, will the effective wages earned by workers increase, decrease or stay the same? And what will happen to worker and producer surplus? Will the change in worker surplus be greater or smaller compared to the change in producer surplus? Explain why. (10 Marks)

4. In a country called Nerdestan, payroll taxes are 60 percent and are legislated to be paid all by workers. However, after the last elections, the Conservative Party takes over the government and reduces the payroll taxes by half. Based on this, consider the following statement: “The reduction in the payroll taxes will shift the labour demand curve to the right. How this rightward shift affects employment depends on the shape of the labour supply curve. The flatter the labour supply curve (i.e. the more elastic), the smaller will be the employment gains and the larger will be the increase in the wages paid to workers.” Is this statement correct? Explain why or why not. (10 Marks)