Practice Problems II EC 102.03 Questions 1. What do the following terms mean and how are they calculated? i. The unemployment rate ii. The labor force participation rate Answer: i.the unemployment rate is defined as the percentage of the labor force that is unemployed: Unemployment rate 100% Unemployed Labor force ii. The labor force participation rate is defined as the percentage of the population of potential workers that is in the labor force: Labor force Labor force participation rate 100% Potential workers 2. What could explain why unemployment is lower among workers with a relatively higher level of education? Answer: As the chapter points out, multiple factors explain why more educated workers have lower rates of unemployment.one such factor is the fact that unemployment is lower among workers with a higher level of education is consistent with the principle of optimization. More educated workers tend to earn higher wages than less educated workers when working outside the home. More educated workers, therefore, have a much higher opportunity cost of time. An unskilled worker who is unemployed is more likely to be indifferent between staying at home or working at a low-paying job. Butfor a skilled worker, the opportunity cost of staying at home is much higher. He or she would be better off getting back to work as quickly as possible. This is because higher wages make the opportunity cost of unemployment much higher for workers with more education. 3. As an economic advisor, you observe that a firm s total revenue is greater than its total cost. Will you recommend the firm to employ more workers to maximize profits? Explain your answer. Answer: Total profit is the difference between total revenue and total cost. Even if total profit is positive, the value of marginal product can be greater than, less than, or equal to the marginal cost. A profit-maximizing firm will employ workers up to the point at which the value of marginal product is equal to the marginal cost. Thus, there isn t enough information to advise the firm about the quantity of workers employed. 4. Change in market wage leads to a shift in the labor demand curve. Is this statement true or false? Explain your answer.
Answer: False. Change in market wage leads to a movement along the labor demand curve. Given the value of the marginal product of labor, there will be a change in the quantity of workers demanded by a firm as the market wage changes. 5. Why does the labor supply curve slope upward, and what can cause the labor supply curve to shift? Answer: The labor supply curve represents the relationship between the quantity of labor supplied and the wage. As the wage increases, the quantity of labor (hours) supplied rises:the opportunity cost of activities other than paid employment increases when the wage increases.so, workers have an incentive to work more hours as their wage increases.accordingly, the labor supply curve is upwardsloping. Each of the following factors affects the entire schedule relating the quantity of labor supplied to the wage and will therefore shift the labor supply curve. Changing tastes and social norms: Changing social norms affect people s willingness to take a paid job. For example, factory work during the Second World War was one early step in a worldwide shift toward acceptance of female labor force participation. This increase in the number of workers shifts the labor supply curve to the right. Changing opportunity cost of time: Household appliances, like dishwashers and vacuum cleaners, lower the opportunity cost of working outside the home. This encourages people to shift more time out of home production into paid employment, generating a rightward shift in the labor supply curve. Changes in population: For example, the influx of immigrants to a country will increase a country s population and shift the labor supply curve to the right. 6. What is meant by job search? How does it lead to frictional unemployment? Answer: Finding the right job is not easy; a job seeker would need to determine which firms are hiring and learn how pay, benefits, and other job characteristics vary among them. He or she would also have to line up references and send out resumes. Interviews will need to be set up, but in most cases, someone else gets chosen, and then the job candidate needs to start all over again. These jobhunting activities are referred to as job search. Unemployment arising from job search is called frictional unemployment. Frictional unemployment arises because it takes time for an unemployed worker to find a firm with a well-matched job vacancy. 7. What is the difference between efficiency wage and market-clearing wage? Answer: Efficiency wages are usually above the market-clearing wage, which is the wage at which labor supply is equal to labor demand. The extra pay increases worker productivity and improves the profitability of a firm. 8. What is wage rigidity? List and explain two factors that can increase wage rigidity in the labor market. Answer: Wage rigidity refers to the situation in which wages are held above the level that clears the labor market. Because firms will not be able to hire workers who would have been willing to work at
the equilibrium wage, wage rigidity leads to unemployment. Some of the factors that increase wage rigidity are the following: Minimum-wage legislation: The minimum wage is a legislated price floor that prevents the market price from falling to the equilibrium price.minimum-wage legislation prevents employers from hiring workers at wages that would equalize the quantity supplied and demanded, leading to unemployment in the market. Collective bargaining: Collective bargaining refers to contract negotiations between an employer and a labor union representing workers. Collective bargaining agreements between unions and employers often result in wages tha are above equilibrium. Efficiency wages: Efficiency wages are set above the market wage in order to increase worker productivity. Firms might find it profitable to pay a higher wage than the market clearing wage in order to boost productivity, lower absenteeism and turnover, boost worker morale, etc. Moreover, paying efficiency wages may well attract higher quality applicants for the available positions. Downward wage rigidity: Workers tend to resist a decline in their wage. In order to maintain productivity and morale, firms often prefer to fire workers than try to cut everyone s wages. This leads to downward wage rigidity. 9. In April 2012, The Bazanian Daily, a leading newspaper in the country of Bazania, carried a report titled 20,000 jobs added in the last quarter; unemployment rate shoots up from 5 percent to 6.7 percent. How could the unemployment rate in Bazania increase even when new jobs were created? Answer: The unemployment rate in a country is calculated as the proportion of the labor force that is unemployed. The unemployment rate can rise if people enter the labor force and only some of them get jobs. For example, suppose that the before data is 1,000,000 workers in the labor force with 950,000 employed and 50,000 unemployed, implying a 5 percent unemployment rate. Suppose that the after data is 1,040,000 workers in the labor force with 970,000 employed (20,000 more than before) and 70,000 unemployed, implying a 6.7 percent unemployment rate. 10. Suppose the equilibrium wage in the market for food service workers is $11 per hour. The government then establishes a minimum wage at $9 per hour.what will be the effect of the minimum wage on the market for labor in the food service industry? Explain. Answer: There will be no effect on the market for labor in the food service industry. In order to have any impact, a minimum wage must constitute a binding price floor, that is, it must be set above the equilibrium wage. Only then will the quantity of labor supplied exceed the quantity of labor demanded, with resulting unemployment. If the minimum wage is set below the equilibrium wage, the equilibrium wage will prevail, and there will be no change in the level of employment. 11. The following graph shows the demand for and supply of labor in a competitive labor market. Use the graph to answer the following questions.
a. What is the value of the market-clearing wage? How many workers are employed? What kind of unemployment may exist? b. Now suppose the firms demand for more workers due to optimistic economic prospects. At the same time, the government allows for the employment of foreign workers. Plot the graphs to show the effects on wage and employment. (Hint: Pay attention to the magnitude of shifts in the demand curves.) c. Continuing from part b, if the minimum wage is set at $8, what will be the effect on wage? Answer: a. The market-clearing wage is $6 and 300 workers are employed. Frictional unemployment may exist. b. Labor demand curve shifts to the right due to higher demand for workers. Labor supply curve shifts to the right due to the influx of foreign workers. There are three possible cases: Case I: If the shift in labor demand is greater than the shift in labor supply, the market-clearing wage and employment will be higher.
Case II: If the shift in labor demand is less than the shift in labor supply, the market-clearing wage will be lower and employment will be higher. Case III: If the shift in labor demand is equal to the shift in labor supply, the market-clearing wage remains the same and employment increases. c. For cases II & III, the market wages have to be raised to $8. For case I, if the market-clearing wage is higher than the minimum wage, then the market wage remains. If the market wage is lower than the minimum wage, then the market wage will have to be raised to $8. 12. The newly elected prime minister of a country in 2014 has promised to reform the labor market. Some proposed changes include relaxing the restrictions on women to work in factories at night and raising the limit for overtime work. What do you think about the objective of such proposed changes? Use a graph to explain your answer. Answer: The objectives of the proposed changes are to increase labor supply and lower the marketclearing wage. As shown in the graph below, a rightward shift in labor supply curve results in more workers employed.
13. According to salary.com, the average salary for a software engineer level III (a higher-level position in software design and implementation) in the Silicon Valley area of California is $108,244.However, Google pays its level III software engineers an average salary of $124,258.Explain why Google would pay a salary higher than the equilibrium salary for equivalent positions in the same area. (Salary data from http://swz.salary.com/salarywizard/software-engineer-iii-salary-details- Mountain-View-CA.aspx; http://www.glassdoor.com/salary/google-salaries-e9079.htm) Answer: This salary differential can be explained using the concept of efficiency wages. Paying a wage above the going rate for a certain category of labor serves to increase the productivity of workers and the profitability of the firm. This is due to several factors such as reduction of worker turnover, lower worker absenteeism, enhancement of worker morale, and the ability to attract higher quality applicants.
14. The following figure shows the demand and supply curves in the market for workers in Starbucks coffee shops, (called baristas ). The hourly wage in this market has been fixed at $6, and cannot be changed. a. Suppose that, due to concerns about the high number of calories in many Starbucks drinks, the demand for Starbucks products declines.use a graph to explain what will happen to employment in the market for baristas. b. Now suppose the wage is flexible. How would your answer to part (a) change? Answer: a. A fall in demand for Starbucks coffee will reduce the demand for labor by coffee shops. The demand for labor curve will shift to the left, as illustrated below. Becausethe wage in the market is fixed at $6 per hour, the quantity of labor supplied at that wage will exceed the quantity demanded, leading to unemployment.for example, in the graph below, 100,000 workers would be unemployed as a result of the inflexible wage. b. With flexible wages, a shift to the left in the demand for labor reduces the equilibrium wage and employment but does not cause unemployment. The demand curve will shift to the left, the wage will fall say, to $5 per hour as illustrated above and the level of employment
will be equal to 250,000 baristas. But at this lower wage, the number of baristas demanded will be equal to the number of baristas supplied; there will be no unemployment in the market.