Econ 371 Marietta College
Problem Set 2  

Answer Key

1.  Start with the production function and throw in the objective of profit maximization and pretty soon you'll get the hiring rule: MRP = w.

2.  In the long run firms will be more easily able to substitute capital for labor.

3.  Given a 15% increase in wages and that E = -0.33, we can calculate that employment will fall by 5%.  Since demand is inelastic, any wage increase will cause the wage bill to increase.

4.  We did this one in class.

5.  Labor demand
a)  labor demand will increase
b)  labor demand will decrease
c)  labor demand will decrease
d)  labor demand will decrease
e)  labor demand will decrease
f)  the labor demand curve will not shift--since wages fell, employers will merely move down the existing curve and hire more workers.

6.  The VMP = MP*P = 5*$6 = $30.  The Hut will hire workers until VMP = w.  Thus, set w = 6 + 0.1E = $30 and solve for E.  This will give E = 240.

7.  E = -0.80; inelastic.

8.  a)  6   (b) 3  (c) 2  (d) Oops, same as part (b)

9. The drop in government R&D spending would decrease the demand for engineers. This would lead to a lower wage and employment level among engineers.

10. The demand for coal miners would increase due to the rising demand for coal (since oil prices were higher). The supply of coal miners would decrease because of the health information (miners would require a compensating differential). The combination of the two events would cause miner wages to rise and employment to be indeterminate.

11. Wages could fall either due to an increase in supply or a decrease in demand. If nominal (money) wages rose each year, the necessary drop in real wages to maintain equilibrium in the labor market could be achieved a slower rate of wage growth in this market compared to others--it's the relative wage that matters. Otherwise, non-wage aspects of the job would have to adjust.

12.  Overpaid means being paid a wage above the equilibrium wage.  If wages are persistently above the equilibrium wage, then we would expect a surplus of workers to result.  A signal of overpaid workers is that there are long waiting lists for job openings in this occupation.  Underpaid means being paid a wage below the equilibrium wage.  A signal of underpaid workers would be high job turnover.

13. (a) The demand for goat herders will decrease if the demand for goat milk and wool  falls.  The supply of goat herders will decrease if wages in similar occupations rise.  The combined effect of rising demand and falling supply will cause the employment of goat herders to fall but the impact on their wages will be indeterminate.  (b) The drop in employment to 28,000 is easily understood according to our analysis in part (a) above.  The rise in wages to $6 is entirely possible if the shift in supply is greater than the shift in demand.

14.  I'll leave this for you to ponder.

15. Initial equilibrium: W = $35; E = 5. After the demand increase, the ultimate equilibrium is: W = $47.50; E = 7.5. However, if the cobweb model is applicable (in which market adjustments occur in one variable at a time, beginning first with wages), then wages will initially rise to $55. The higher wage will make quantity supplied equal 9. At E = 9, wages will be depressed to $43. At W = $43, quantity supplied will be 6.6. At E = 6.6, wages will be $50.2. The iterative process continues until wages and employment reach the ultimate equilibrium mentioned above.

16.  We did this one in class.

17.  Compare your answers to your neighbor.

18.  This is for you to ponder.

19.  This is in your textbook.

20.  Labor market efficiency is defined as the situation where no worker can be switched from one job (compensation scheme) to another to produce more economic well-being.

21.  This is in your textbook.

22.  This is in your book and notes.

23.  Mandatory retirement age is 60.

24. Workers with VMPs below $35 will want to work for Firm A while workers with VMPs above $35 will want to work for Firm B. This means Firm A will employ 35 workers and Firm B will employ 65 workers.  When demand falls, and assuming that Firm A still pays a time rate of $35, then Firm A will find that the first 75 workers now want to work for it.  Meanwhile, Firm B will see that only the top 25 most productive workers will want to work for it.

25.  This is for you to work out.

26.  Talk this one over with your neighbor.

27.  Efficiency wages are paid when wages are above the market clearing level. Firms may do this in order to reduce various principal agent problems such as shirking. Such wages tend to generate unemployment in these labor markets.

28.  Speculate.

29. Consider the theory of tournaments and how they are designed to elicit effort from all participants.