Proposal 1: Require that each medical student complete one rotation at a qualified geriatric care facility.

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Stephany Turner
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1 Instructions The questions below are arranged into two groups according to the estimated time and difficulty. Group A are relatively short, should require 5 10 minute each, and are worth 25 points each. Group B are more complicated, require more time (10 15 minutes each), and are worth 50 points each. The opportunity cost of answering one question in Group B is not answering two questions in Group A. You are to answer any combination of questions that sum to exactly 200 points. Group A: 25 point questions (estimated time 5 10 minutes) 1. Currently physicians are required to spend at least one year in post-graduate training in a hospital or other certified care center before they can be fully licensed. A presidential candidate has decided to propose a bill modifying the requirements for obtaining medical licenses to increase medical care for the elderly. The candidate asks you to evaluate the following two proposals which are to provide the same level of care to the elderly. You are instructed to ignore the funding sources and concentrate on the efficiency [Pareto optimality] of the programs. Proposal 1: Require that each medical student complete one rotation at a qualified geriatric care facility. Proposal 2: Create a fund to pay medical students to work for one year in a qualified geriatric care facility. PROPOSAL 2: DOCTORS ARE PUBLICALLY FUNDED AND CHOOSE THIS EMPLOYMENT VOLUNTARILY. IT THEREFORE HAS ONE MAJOR ADVANTAGE OVER PROPOSAL 1, IN WHICH DOCTORS PARTICIPATION IS MANDATORY. UNDER PROPOSAL 2, SOCIETY IS ASSURED THAT THE DOCOTRS VIEW THE JOB AS IMPROVING THEIR WELFARE; THAT IT IS THE BEST ALTERNATIVE AVAILABLE TO THEM. WHEN THE PROGRAM IS MANDATORY, AT LEAST SOME OF THE DOCTORS MAY CONSIDER OTHER ALTERNATIVE EMPLOYMENT AS SUPERIOR TO GERIATRIC CARE. THESE DOCTORS WOULD BE FORCED TO PARTICIPATE IN A TRANSACTION THEY SEE AS DETRIMENTAL TO THEIR WELFARE. ALLOWING THESE DOCTORS TO CHANGE EMPLOYMENT WOULD IMPROVE SOCIAL WELFARE THROUGH THE REALLOCATION OF RESOURCES. ONE ISSUE THAT IS NOT REQUIRED, BUT MAY BE OF INTEREST: THE QUALITY OF THE CARE MIGHT DIFFER UNDER THE TWO PROPOSALS, BUT THE QUESTION ABSTRACTS FROM THIS ISSUE. Test1_sp08_answer.doc 1 of 6

2 2. We use the same tools to study labor markets as we use to study product markets. Yet many would argue that labor markets are very different institutions. One unique characteristic of labor markets is that the commodity exchanged (labor hours) cannot be separated from the owner. In the product market, price is use to measure both the benefit received by the seller of the commodity and the cost to the buyer of obtaining the commodity. Explain clearly why it may be problematic to use the wage to measure the benefit received by the worker in return for hours of labor supplied. UNLIKE MOST COMMODITIES IN WHICH THE OWNER AND THE PRODUCT CAN BE SEPARATED, IT IS IMPOSSIBLE TO SEPARATE THE SELLER OF LABOR FROM THE LABOR ITSELF. THUS THE CONDITIONS UNDER WHICH THE LABOR IS EMPLOYED IS AN ESSENTIAL CONSIDERATION IN THE EMPLOYMENT RELATIONSHIP. WAGE ALONE, WITHOUT CONSIDERATION OF THESE CONDITIONS, MAY NOT ADEQUATELY VALUE THE BENEFITS DERIVED FROM EMPLOYMENT. 3. The real wage can be expressed in terms of physical output as: W/P = MP L (see page 65 of Ehrenberg and Smith, 9 th ed.) This expression suggests that as labor productivity (MP L ) increases real wages should increase. From 2002 through 2007 labor productivity (output per hour) increased each year by between 6.9% and 2.1%, but the real wage for full-time wage and salary workers (in constant 1982 dollars) as measured by median weekly earnings actually declined slightly from $326 to $323 per week. Clearly explain this apparent discrepancy. THE MODEL ON PAGE 65 IS SHORT RUN WITH ONLY ONE VARIABLE INPUT. THE GOVERNMENT DATA ATTRIBUTES ALL OF THE INCREASED PRODUCTIVITY TO LABOR, WHEN IN FACT THE PRODUCTIVITY OF OTHER INPUTS (CAPITAL) HAS ALSO INCREASED. THIS WOULD ARGUE WAGE GROWTH SHOULD BE LOWER THAN THE 6.9% TO 2.1%, BUT NOT ZERO. ANOTHER ISSUE IS HOW THE WAGE GROWTH IS CALCULATED. THESE DATA ARE FOR WAGE AND SALARY WORKERS ONLY. THE DATA ARE ALSO FOR WEEKLY EARNING; THUS THE AVERAGE WORKWEEK MAY HAVE SHRUNK. COMPENSATION TO OTHER UNITS OF LABOR MAY HAVE INCREASED AND THE PRODUCTIVITY OF THESE WORKERS MAY NOT HAVE INCREASED. ANOTHER POSSIBLE EXPLANATION IS THAT SOME OF THE INCREASED PRODUCTIVITY FROM LABOR WAS DISTRIBUTED TO OTHER FACTORS OF PRODUCTION, BUT THE DATA GIVEN DOES NOT SHED LIGHT ON THIS ISSUE. Test1_sp08_answer.doc 2 of 6

3 4. The December 2007 issue of the Ohio Labor Market Review reported that from December 2006 to December 2007 civilian employment increased by 34,000 (5,624,000 to 5,658,000) and the number unemployed increased by 27,000 (334,000 to 361,000). Explain the labor market flows involved and why this was not great news for the Ohio economy. THE NUMBER OF EMPLOYED (E) INCREASED, WHICH IS GOOD NEWS. HOWEVER, THE NUMBER OF UNEMPLOYED ALSO INCREASED. THUS THE LABOR FORCE INCREASED AT A FASTER RATE THAN EMPLOYMENT. THUS THE GROWTH IN EMPLOYMENT WAS INSUFFICIENT TO ABSORB NEW ENTRANTS TO THE LABOR MARKET. THIS IS NOT GOOD NEWS, SINCE THE ECONOMY IS NOT GROWING FAST ENOUGH TO KEEP UP WITH THE GROWTH IN THE LABOR FORCE. 5. Find the profit maximizing number of units of labor for a small local machine shop which operates in competitive labor and product markets. The firm faces the following production function and market prices. 2 a. Production function: Q = L 0.5L b. Output price: P x = $ 50 c. Market wage: w = $ 250 OPTIMUM LABOR USAGE REQUIRES MRP L = ME L ; WHEN THERE IS PERFECT COMPETITION IS BOTH THE PRODUCT AND LABOR MARKETS, THIS REDUCES TO MP L *P x = w. MP L = 25 L; SO (25 L)*50 = 250; L = 250; 50L = 1000; THEREFORE, L = 20 UNITS OF LABOR. 6. If the short-run supply of capital is relatively less elastic than its long-run supply, what does this imply about the short-run own-wage elasticity for demand for labor compared to the long-run own-wage elasticity for labor? Explain. ONE OF MARSHALL S RULES INDICATES THAT THE LESS ELASTIC THE SUPPLY OF OTHER INPUTS THE LESS ELASTIC THE DEMAND FOR LABOR. THUS, SINCE THE SUPPLY OF CAPITAL IS LESS ELASTIC IN THE SHORT-RUN, ONE WOULD EXPECT THE SHORT-RUN DEMAND FOR LABOR TO ALSO BE LESS ELASTIC, HOLDING ALL OTHER THING CONSTANT. Test1_sp08_answer.doc 3 of 6

4 7. An empirical study by Daniel Hamermesh (Economic Inquiry, July 1982, pp ) found that for every 100 teenagers who might be employed as a result of a youth sub minimum wage, between 11 and 33 adult workers would be displaced. According to this finding, are teenagers and adult workers gross complements or gross substitutes? Be sure to discuss the 1) substitution and scale effects, 2) the sign of the cross-wage elasticity between teenagers and adults and 3) the expected impact on the demand curve for adult workers if the wage paid to teenagers falls from the imposition of a sub-minimum? THE DECREASE IN THE TEENAGE WAGE CAUSES A DECLINE IN THE EMPLOYMENT OF ADULTS. THUS ADULTS AND TEENAGERS ARE GROSS SUBSTITUTES AND THE CROSS-WAGE ELASTICITY [(de/dw)*(w/e)] IS POSITIVE. SUBSTITUTION EFFECT: THE DECLINE IN THE TEENAGE WAGE CAUSES THE MP/W FOR TEENAGERS TO INCREASE AND TEENAGE LABOR WILL BE SUBSTITUTED FOR ADULT LABOR. SCALE EFFECT: THE LOSER COST OF PRODUCTION WILL INCREASE THE PROFIT MAXIMIZING OUTPUT AND INCREASE THE USE OF ALL INPUTS. IN THIS STUDY THE SUBSTITUTION EFFECT DOMINATES THE SCALE EFFECT. WE SHOULD EXPECT THE DEMAND FOR ADULT WORKERS TO DECLINE (SHIFT TO LEFT) SLIGHTLY. 8. Consider a developing country where the price of an acre of land is p a, the wage rate for agricultural workers is w, and the aggregate labor demand for agricultural workers in given by: L d = w 5p a a. Calculate the own-wage elasticity of labor w = 3 and p a = 200. b. Is the own-wage elasticity of demand for labor elastic or inelastic at this point? c. Are workers and land gross complements or substitutes? Explain. δl w A. OWN-WAGE ELASTICITY: * = 75* = = δw L B. SINCE THE ABSOLUTE ELASTICITY IS LESS THAN 1, IT IS INELASTIC C. IF PRICE OF LAND INCREASES, THE QUANTITY OF LABOR DEMANDED WILL DECREASE. THEREFORE THEY ARE GROSS COMPLEMENTS. Test1_sp08_answer.doc 4 of 6

5 Group B: 50 point questions (estimated time minutes) 9. Presidential candidate Obama has pledged to remove one to two combat brigades each month from Iraq and have all of our combat brigades out of Iraq within 16 months. a. Discuss and show how decreased dangers of military service (because of fewer troops in Iraq) would change the market demand and supply curves for military personnel. b. Discuss and show how the removal of troops from Iraq and a decrease in the size of the full-time military would change the market demand and supply curves. c. Use your analysis to predict how the Senator Obama s pledge will affect the wages and the employment level of military personnel. A. DECREASED DANGERS SHOULD SHIFT Ls TO THE RIGHT (INCREASE); with explanation of why this make military service more attractive. B. DECREASE OF TROOPS SHOULD SHIFT Ld TO THE LEFT; with explanation that government needs less security thus decreasing labor demand. C. BOTH A AND B WILL REDUCE THE EQUILIBRIUM WAGE, THIS IT WILL TEND TO DECREASE. HOWEVER, A TENDS TO INCREASE THE QUANTITY DEMANDED WHILE B TENDS TO REDUCE THE QUANTITY DEMAND. SO THE IMPACT ON EMPLOYMENT IS UNCERTAIN. Comment that net effect depends on relative size of shifts and relative elasticity shows deeper understanding. 10. Congress has recently passed an economic stimulus plan. The plan allows businesses that buy new equipment this year to deduct an additional 50 percent of the cost of their investment in However, it does not include an extension of unemployment benefits for individuals who have been unemployed for over 6 months. a. Thinking of the factors which underlie the elasticity of the demand for labor (Hicks-Marshall rules), analyze the impact on employment in the U.S. of the business tax deduction for investment. b. Thinking of the factors which underlie the elasticity of the demand for labor (Hicks-Marshall rules), analyze the impact on employment in the U.S. if the unemployment extension had been part of the package. A. THE TAX REDUCTION REDUCES THE COST OF CAPITAL RELATIVE TO LABOR. THIS WILL TEND TO DECREASE THE DEMAND FOR LABOR IF IT IS A GROSS SUBSTITUTE FOR CAPITAL LOW SKILL LABOR. IT WILL TEND TO INCREASE THE DEMAND FOR LABOR IF IT IS A GROSS COMPLEMENT OF CAPITAL SKILLED LABOR. H-M rules: elasticity of the demand for output (#1) and share of total cost (#4) help estimate the relative size of the scale effect. H-M rules: degree of substitution between factors (#2) and elasticity of supply of other factors help estimate the relative size of the substitution effect. B. THIS PROGRAM DOES NOT AFFECT THE Ld, BUT THE Ls, THUS THE H-M LAWS HAVE LITTLE TO SAY. THE PROGRAM WILL TEND TO 1) INCREASE THE SUPPLY OF LABOR (SOME WHO HAVE NOT FOUND JOBS WILL CONTINUE TO SEARCH RATHER THAN DROPPING OUT OF THE LF; 2) INCREASE THE TIME WORKERS TAKE TO FIND NEW JOBS POSSIBLY INCREASE THE AVERAGE WAGE THEY RECEIVE; 3) INCREASE SHORT RUN DISPOSABLE INCOME AND THUS MAY KEEP AGGREGATE DEMAND FROM FALLING AS RAPIDLY. Test1_sp08_answer.doc 5 of 6

6 11. Consider an economy with the following aggregate labor demand and supply. L d = w L s = w a. Determine the equilibrium wage and units of labor employed. b. What is the value of economic rent (similar to consumer surplus in product market) earned by workers? c. How many workers would lose their job if a minimum wage of $8 per unit of labor is imposed? Explain. d. Calculate the unemployment rate with the $8 per hour minimum wage. A. L d = w = w = L s 105 = 15 w; w = $7.00 L = (7) = 90 B. (7*20) + [(90-20) * 7] / 2 = /2 = 385 C. L d = (8) = = 85; So 5 workers loose jobs C. L d = (8) = = 85; L s = (8) = = 100; ue rate = 15/100 = 15% 12. Clerical workers represent a substantial share of the U.S. work force -- over 15 percent in recent years. Concern has been expressed that computerization and office automation will lead to a substantial decline in white-collar employment and increased unemployment of clerical workers. Is this concern well founded? [Hint: Consider both the substitution and scale effects.] OFFICES HAVE BECOME MORE COMPUTERIZED IN RECENT YEARS BECAUSE THE COST OF USING COMPUTERS FALLS RELATIVE TO LABOR'S PRICE (THE WAGE RATE). THIS CAUSES A SUBSTITUTION EFFECT, TENDING TO SHIFT THE LABOR DEMAND CURVE TO THE LEFT FOR CATEGORIES OF LABOR THAT ARE SUBSTITUTES IN PRODUCTION WITH CAPITAL. HOWEVER, THERE IS ALSO A SCALE EFFECT TENDING TO INCREASE EMPLOYMENT FOR THE ABOVE CATEGORIES, SO WE CANNOT TELL IN ADVANCE WHICH EFFECT WILL DOMINATE. (FOR LABOR CATEGORIES THAT ARE COMPLEMENTARY WITH CAPITAL IN THE PRODUCTION PROCESS, THE LABOR DEMAND CURVE CLEARLY SHIFTS TO THE RIGHT.) THEREFORE, IT IS NOT NECESSARILY TRUE THAT WHITE-COLLAR EMPLOYMENT WILL FALL; THE SCALE EFFECT MAY PREVAIL FOR MANY OF THESE JOBS (A DOMINANT SCALE EFFECT IS MORE LIKELY IF PRODUCT DEMAND IS ELASTIC, IF IT IS DIFFICULT TO SUBSTITUTE CAPITAL FOR LABOR, AND IF THE SHARE OF CAPITAL IN TOTAL COST IS LARGE). [SOME MAY INFER THAT CLERICAL WORKERS ARE GROSS SUBSTITUTES WITH CAPITAL AND WHITE-COLLAR WORKERS ARE GROSS COMPLEMENTS, BUT THIS IS NOT NECESSARY.] Test1_sp08_answer.doc 6 of 6

Review Questions. The Own-Wage Elasticity of Labor Demand. Choose the letter that represents the BEST response.

Review Questions. The Own-Wage Elasticity of Labor Demand. Choose the letter that represents the BEST response. Chapter 4 Labor Demand Elasticities 49 Review Questions Choose the letter that represents the BEST response. The Own-Wage Elasticity of Labor Demand 1. If the wage paid to automobile workers goes up by