02 Jun Question 1. An increase in the wage can cause an increase in leis
Question
1. An increase in the wage can cause an increase in leisure when the substitution effect (of the
change in wage on leisure) is positive. True/false/explain.
2. Assume that there is only one earner in a family and that she can earn $10 an hour. There are
100 hours a week available for work or leisure. There are 50 work-weeks per year. The welfare
program provides $10,000 per year if she has zero earnings. For every dollar earned, her welfare
check is reduced by 25 cents. For example, if she earns $10,000 from work, she receives $7500
from the welfare program. Use wage = $10. If she earns $40,000 or more, she is not eligible to
receive welfare payments.
a. Draw the annual budget constraint for this family in the absence of a welfare program. Next,
add a budget constraint that reflects the existence of the welfare program. Label clearly.
b. Use a new graph to show that, without the welfare program, the earner would maximize utility
by working 40 hours per week (2000 hours per year). Show total hours of leisure and total hours
of work per year. What are yearly earnings?
c. Use a new graph (of annual numbers again). Add the welfare program to the graph you drew
in (b) and show the utility-maximizing combination of leisure and consumption at 30 hours of
work per week (1500 hours annually). What are yearly earnings? What is the effect of the
welfare system on the well-being of the family? Geometrically speaking, why does the model not
permit pre-welfare and post-welfare hours worked to be the same? What worker characteristic
would have to change to make the same hours of work possible before and after the welfare
program?
d. Now assume that, without the welfare program, the earner would choose to work 20 hours per
week. How much does she earn per year? How many hours will she choose to work per year
when she has the option of receiving welfare? Show on a new diagram.
3a. What happens to the firm’s long-run labor-demand curve if the demand for the firm’s output
increases? Explain in words–no graph required.
b. What happens to the firm’s long-run labor-demand curve if the price of capital decreases?
Explain, using the isoquant-isocost model.
4. Consider a firm for which production depends on two normal inputs, labor and capital, with
prices w and r, respectively. Initially, the firm faces market prices of w = 12 and r = 8. Then the
wage rate falls to 8 and the rental rate on capital falls to 4.
a. In which direction will the substitution effect change the firm’s employment of labor and
capital? Explain in words.
b. In which direction will the scale effect change the firm’s employment of labor and capital?
Explain in words.
c. Can it be conclusively determined whether the firm will use more or less labor? More or less
capital? Explain your answer in words.
5. Suppose a firm hires labor in a competitive labor market and sells its output in a competitive
product market. The firm’s elasticity of demand for labor is -0.4. If the wage increases by 20
percent, what will happen to the number of workers hired by the firm? What will happen to the
marginal productivity of the marginal worker hired by the firm?
6. Union A wants to represent workers in a firm that would hire 2,000 workers if the wage rate is
$12 and would hire 1000 workers if the wage rate is $15. Union B wants to represent workers in
a firm that would hire 3000 workers if the wage rate is $20 and would hire 3300 workers if the
wage rate is $15. Which union is more likely to be successful in organizing? Explain.
7. Suppose that some enterprising students open Cookies R Us, a cookie factory, in an unused
area of one of the dorms. They employ eight workers, paying each worker $8.00 per hour. They
charge $1.00 per cookie.
a. Assume that CRU is a price-taker that is maximizing profits. According to the short-run model
of a profit-maximizing firm, what is the hourly marginal product of the last worker hired?
b. One of the student-owners invents a process that doubles the marginal product of labor. Using
a supply and demand model of the cookie market (and your extensive knowledge of
microeconomic principles), what effect would be expected on the price of cookies from the
technological innovation?
c. Given the increase in productivity and your answer in (b), what effect will this new process
have on the wage in the market for cookie makers? Use a model of the labor market in your
answer.
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