现代劳动经济学课后【伊兰伯格】课后习题答案

)].

Note that this elasticity estimate does not vary with the end of the wage interval (high or

low) at which one starts. In the present question the average elasticities for union A and

union B are given by

Elas. (A): [(20,000-10,000)/15,000]/[(4.00-5.00)/4.50] = (2/3)/(-2/9) = -3

Elas. (B): [(33,000-30,000)/31,500]/[(5.00-6.00)/5.50] = -.524

Given the above data, union A faces the more elastic demand curve.

(b) One cannot say which union will be more successful in increasing its members' total

earnings. This depends upon a number of factors, including the bargaining power of the

two unions and the firms with which they deal. It is true, however, that the union with the

more elastic demand curve will suffer a larger percentage employment loss for any given

percentage increase in wages, and this is likely to reduce its incentive to push for large

wage gains. Thus, one's inclination is to say that the union facing the less elastic demand

curve is likely to be more successful in raising its members' wages.

(This answer assumes that wage/employment contracts under collective bargaining lie on

the demand-for-labor curve. As shown in the appendix to Chapter 12, this need not

always be the case.)

4.

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?

Answer: Offices have become more computerized in recent years because the cost of

using computers has fallen 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).

22

Even if labor demand shifts left for a particular occupational category, unemployment

will not be the long-term result unless wages are rigid. Adversely affected workers would

have to

shift to

other occupations and may experience some transitional joblessness, but

only if wages are rigid and employees refuse to shift to lower paying jobs will their

unemployment be permanent.

6.

In 1942 the government promulgated regulations that prohibited the manufacture of

many types of garments by workers who did the sewing, stitching, and knitting in

their homes. If these prohibitions are repealed, so that clothing items may now be

made either by workers in factories or by independent contractors doing work in their

homes, what effect will repealing the prohibitions have on the labor demand curve for

factory

workers in

the garment industry?

Answer : Repealing the prohibitions enables garment manufacturers to substitute home

workers for factory workers. Assuming that the 1942 regulations were constraining, one

can presume that there will be at least some substitution of home workers for factory

workers; this substitution will tend to shift the labor demand curve for factory workers to

the left. However, there may be a favorable scale effect for certain factory workers

performing tasks (such as packaging and shipping) complementary with home production.

Besides the shift to the left of the labor demand curve, the new substitution possibilities

opened up by repealing the 1942 regulations should serve to make the labor demand

curve for factory workers more elastic. Just as the greater ability to substitute capital for

labor will tend to make the labor demand curve more elastic, so too will the ability to

substitute home labor for factory workers.

Answers to Even-Numbered Problems

Ed: the answer to problem 2 is to be changed:

2.

Professor Pessimist argues before Congress that reducing the size of the military will

have grave consequences for the typical American worker. He argues that if one million

individuals were released from the military and were instead employed in the civilian

labor market, average wages in the civilian labor market would fall dramatically.

Assume that the demand curve for civilian labor does not shift when workers are

released from the military. First, draw a simple diagram depicting the effect of this

influx of workers from the military. Next, using your knowledge of a) the definition of

the own-wage elasticity of labor demand, b) the magnitude of this elasticity for the

economy as a whole, and c) the size of civilian employment in comparison to this flood

from the military, graph these events and estimate the magnitude of the reduction in

wages for civilian workers as a whole. Do you concur with Professor Pessimist?

Answer. Because you were asked about the effects on civilian wages as a whole, you will

probably

not

concur with Professor Pessimist. Own-wage elasticity of demand for labor

= %

?

(quantity demanded)/%

?

(wage) = (

?

Ld

/

Ld

)/(

?

W/W

). In this case

?

Ld

= 1 million,

Ld

= about 135 million employed workers, and the own-wage elasticity of demand for

23

labor is approximately -1. Thus, -1 = (1 million/135 million)/(

?

W< /p>

/

W

), so

?

W/W

will be

very small -- about -1/135 (or -0.0074). This implies that wages will fall by 0.74 percent.

However, the military recruits in a very narrow segment of the labor market--

mostly high school grads who do not attend college, and who are between ages 17-21.

Thus, downsizing would have the greatest effect on this segment of the market. If there

were only 13.5 million, say, in this age group, a labor demand elasticity of

–

1 would yield

a wage effect of the military downsizing of closer to

–

7.4% on this group of the

population.

4. (Appendix) The production possibilities curve for the United States is linear and

allows it to produce a maximum of 500 million units of clothing or 300 million units

of food. The production possibilities curve for France is also linear and allows it to

produce a maximum of 250 million units of clothing or 150 million units of food.

Which good will the United States export to France?

Answer: Neither. The two countries have the same opportunity cost, so neither has a

comparative advantage in either good.

Suggested Essay Questions

1.

The public utilities commission in a state lifts price controls on the sale of natural gas

to manufacturing plants and allows utilities to charge market prices (which are 30%

higher). What conditions would minimize the extent of manufacturing job loss

associated with this price increase?

Answer. This question involves the cross-elasticity of demand. A higher price of natural

gas will have a substitution effect that could favor increased employment, and a scale

effect that tends to reduce employment. Factors that minimize the extent of job loss are

those that make for a robust substitution effect and a small scale effect. A large

substitution effect will tend to occur if labor is easily substituted for natural gas in the

production process, and if the supply of labor is relatively elastic. A small scale effect

would be created if natural gas is a small part of the overall cost of production, and if the

demand for the products made using natural gas is relatively inelastic.

2.

One anti- terrorism expert proposes the development of two capabilities that would

protect shipments of hazardous materials by truck. One is to maintain continuous

satellite monitoring of all such shipments, and the other is to install devices that

automatically shut down any truck that has been hijacked or deviates from its

approved route. Discuss how implementing this proposal is likely to affect the

demand for truck drivers, noting especially the conditions under which this effect is

likely to be largest.

Answer. This proposal is an attempt to monitor truck drivers, and it really raises the cost

of labor (trucks now require both a driver and monitoring equipment). Thus, the four

factors underlying the elasticity of labor demand are relevant. Where it is easier to

substitute capital for labor, then trucks will tend to get bigger and the number of drivers

24

needed will go down more. The substitution effect will also be larger if the supply of

capital (in the form of larger trucks) is elastic. If product demand is more elastic, the scale

effect will be larger and product demand will go down more. Finally, where the

monitoring equipment represents a larger share of overall cost, the scale effect will be

larger.

3.

(Appendix). One observer of the North American Free Trade Agreement (NAFTA)

claims that, contrary to expectations, jobs in Mexican agriculture have been destroyed

while jobs in the industrialized cities of northern Mexico have expanded. Assuming

the facts on job loss and employment gains are accurate, are they consistent with

economic theory?

Answer. Free trade allows countries to specialize in producing goods and services that

have the lowest internal opportunity cost (that is, to specialize in goods for which they

have a comparative advantage). If we think of two generalized goods (agricultural goods

and manufactured goods), a country becomes more efficient in the production of

manufactured goods will, by the definition of opportunity cost, become less efficient in

the production of agricultural goods. If Mexico has a comparative advantage in the

production of manufactured goods, it must have a comparative disadvantage in the

production of agricultural goods. Thus, the assumed facts in the question are quite

consistent with economic theory.

25

CHAPTER 5 - QUASI-FIXED LABOR COSTS AND THEIR

EFFECTS ON DEMAND

This chapter is designed to analyze the effects of quasi-fixed costs on the demand for

labor. We begin the chapter with a descriptive section on the magnitude and growth of

nonwage labor costs, because the quasi- fixed costs of labor are generally nonwage in

nature. In this section we discuss employee benefits (not all of which are quasi- fixed in

nature), and we also introduce the concept of hiring and training costs.

One implication of the existence of both variable and quasi-fixed labor costs is that there

arises a trade-off between increasing employment through hiring added workers and

increasing employment through hiring workers for longer hours. This trade-off is

discussed in the second section of the chapter, and the importance of distinguishing

between employment and hours is highlighted in our policy analysis of the overtime pay

premium and mandated benefits for part-time workers.

In the third major section we move from a general discussion of quasi-fixed labor costs to

an in-depth analysis of one particular kind of quasi-fixed cost: firms' labor investments.

An investment is a type of expenditure that occurs primarily in some initial period and

then does not recur. While the firm hopes to recoup the investment over a period it

expects the worker to be with the firm, the cost of investment becomes a

This section analyzes the implications of these labor investment characteristics for the

demand for labor (after first introducing the concept of present value and modeling the

labor investment decision by the firm).

The fourth and fifth sections offer detailed analyses of the two principal types of labor

investments: training investments and hiring investments. In the section on training

investments the student is introduced to the notion of general and specific training, as

well as to the implications of training investments for the demand for labor. While

Chapter 9 also covers aspects of education and training, it is our belief that this

introduction to human capital theory in Chapter 5 is useful. In this chapter, as throughout

the text, we introduce particular concepts or tools as they are called for by the larger

context of analysis, because by maintaining a clear view of the overall context of analysis,

the student is better able to learn the insights that economics has to offer. In this

particular case, we deliberately chose to spread the concepts of human capital theory

across different chapters--using these concepts as necessary and maintaining the overall

substantive organization of the text (built around demand and supply).

For similar reasons, the section on hiring investments includes a discussion of credentials

and signaling, as well as an introduction to the concept of internal labor markets. These

topics are also discussed elsewhere in the text (notably in Chapters 11 and 12), but we

felt that a complete discussion of the effects of quasi-fixed costs on the demand for labor

was impossible without a discussion of these concepts. Again, we wanted to maintain the

organizational overview in the minds of the students. (We also firmly believe that

discussing concepts or phenomena in several contexts and at different points in the book

reinforces the learning process.)

26

List of Major Concepts

1.

The distinction between variable and quasi-fixed labor costs is made.

2.

The relative growth of wage and non- wage costs is presented.

3.

The essential characteristic of an investment is that resources are expended in the

current period and returns are received later; the principal types of labor investments

that firms undertake relate to training and hiring.

4.

There are both explicit and implicit costs of job training.

5.

Employee benefits are categorized and the types typically received are listed.

6.

The presence of quasi-fixed costs causes an employment/hours trade-off, and the firm

must determine its optimum mix of employment and hours per worker.

7.

Increased overtime pay premiums that might be required under the Fair Labor

Standards Act would tend to reduce the use of overtime, but whether they increase the

number of workers employed depends on the size of the reduction in total labor hours

demanded.

8.

The concept of present value and the need for discounting when economic decisions

are made in the context of several time periods are discussed.

9.

The multi-period demand for labor, the way this demand is affected by investment

costs in the initial period of hire, and the way investment costs alter profit-

maximizing conditions with respect to labor are all generalizations of the single-

period analysis in Chapter 3.

10. The distinction between general and specific training is defined, and the effects of

specific training on the relationship between wages and marginal productivity is

analyzed.

11. Training investments are recouped through the creation of a

marginal product and wage) that also cushions the worker from layoffs over the

business cycle.

12. The presence of hiring costs induces firms to use credentials and internal labor

markets in the recruiting, selection and promotion processes.

13. Like training costs, hiring investments increase the productivity of selected job

applicants (by distinguishing among them on the basis of productivity), and they are

recouped by paying wages less than productivity.

27

Answers to Even-Numbered Review Questions

2.

When plants close, firms usually must incur various costs associated with laying off

its workers, including processing necessary forms, helping them find other jobs, and

paying them severance allowances. Suppose that industry X finds itself in a much

more competitive product market than it used to face, and that firms in the industry

now have a greater probability of closing than they used to have. How might this

change affect (a) the number of employees hired in the industry, and (b) their average

hours of work?

Answer. Firing costs are quasi-fixed, because they are associated with

workers

, not hours

of work. When they are increased, as they are in industry X, this will induce firms to (a)

hire fewer workers, and (b) work those they hire for more hours.

4. Workers in a certain job are trained by the company, and the company calculates that

to recoup its investment costs the workers’ wages must be $$5 per hour below their

marginal productivity. Suppose that after training, wages are set at $$5 below

marginal productivity, but that developments in the product market quickly (and

permanently) reduce marginal productivity by $$2 per hour. If the company does not

feel it can lower wages or employee benefits, how will its employment level be

affected in the short-run? How will its employment level be affected in the long run?

Explain, being sure to define what you mean by short-run and long-run!

Answer. In the short run (that is, when training investments have already been

concluded, so all that is variable is the employment levels of trained workers), marginal

revenue product still exceeds wages by $$3 per hour, so it is advantageous for the

company to continue employing workers it has already trained. The company is not

making back enough to make the training be a good investment, but making back $$3 per

hour is better than laying off the workers and making back nothing! Thus, workers will

not be laid off.

In the long run (that is, when the company is deciding about investing in new workers),

the $$3 payback per hour is not sufficient to justify the training investment if wages

remain as they are. Thus, the firm will not hire and train new workers under the current

circumstances. Employment will fall as the firm fails to replace those who leave, and the

decline in employment will eventually serve to raise the marginal productivity of labor.

The decline in employment will stop when the marginal revenue product of labor is once

again $$5 greater than the wage rate.

6.

Suppose that the United States adopts a policy requiring employers to offer 600 hours

of paid leave for mothers of newly born babies. Assuming wages remain the same,

analyze the labor demand effects of mandated paid child-care leave on women of

childbearing age and on women past childbearing age.

Answer: This policy clearly increases the expected cost of employing women of

childbearing age by imposing on employers a quasi-fixed cost (equal to 600 hours of

28

normal earnings). This increased cost, with wages remaining equal, will reduce the

demand for younger women; the quasi-fixed nature of the cost implies that their

employment will fall more than their average hours of work.

For older women, for whom the costs of employment are unaffected, there will be both

scale and substitution effects. The former will tend to reduce demand for their services,

while the latter will tend to increase it. The overall effects of this policy on the demand

for older women cannot be predicted from theory alone (however, the four factors

affecting the elasticity of demand for labor can be used to analyze when the substitution

effect will be large relative to the scale effect).

8.

Major league baseball teams scout and hire younger players whom they then train in

the minor leagues for a period of three to five years. Very few of their trainees

(perhaps 5%) actually make it to the major leagues, but if they do they are bound to

the team that owns their contract for a period of six years. After six years, the player

can become a

Keeping in mind that the major league teams pay the costs of, but derive no revenues

from, their minor league teams, what would be the most important predictable effects

of allowing players to become free agents immediately upon entry into the major

leagues?

Answer: During the training period, teams are paying the salaries of their minor league

players and expending other resources on their training without receiving any revenues in

return. These costs represent investments in general training. A firm has no incentives to

offer general training at its own expense unless it can somehow tie the trainee to the firm

for a period long enough to recoup its investment expenditures. The rule under which

players are tied to the major league team owning their contract is intended to offer teams

a period over which to recoup these general training expenses.

If players were able to become free agents immediately upon making it to the major

leagues, teams that did not train these players would bid their wages up to a level equal to

their marginal productivity. Teams offering the training would therefore have no way of

recouping their investment expenditures, which can only be done by paying a wage less

than marginal productivity. Thus, with immediate free agency, teams would no longer

have incentives to scout and train their own players, and they would tend to adopt a

strategy of

immediate free agency would therefore be to destroy the current minor league

arrangements for training players. The major league teams might give up their minor

league teams and rely solely on colleges for training professional baseball players.

Immediate free agency might also cause independent baseball training schools to arise,

with tuition charged directly to the trainees. A final alternative might be for the major

league baseball teams to

collectively

operate a minor league system that is financed by

assessing each team an equal share of the total costs of running the training operation.

29

Answers to Even-Numbered Problems

2. Suppose that a firm is considering training a worker. The worker's

MP

L

is $$100

during the training period, but rises to $$200 in the post-training period. The worker's

wage is $$100 during the training period, the cost of training is $$50 and the discount

rate is 10%. What is the most that a profit-maximizing firm can afford to pay the

worker in the second period?

Answer: The firm will undertake the training if the discounted net benefits from the post-

training period exceed the net expense from the training period, i.e., if

W

0

+

Z

-

MP

0

<

(

MP

1

-

W

1

)/(1 +

r

). Plug in the values to solve for

W

1

at the breakeven point. $$100 + $$50

- $$100 = ($$200 -

W

1

)/1.1, or $$50x1.1 = $$200 -

W

1

, so

W

1

= $$145. If the post-training

wage is less than $$145, the firm will make a profit.

Suggested Essay Questions

1.

The manager of a major league baseball team argues: “Even if I thought Player X

was washed up, I couldn’t get rid of him. He’s in the third year of a four

-year, $$24-

million de

al. Our team is in no position financially to eat the rest of his contract.”

Analyze the manager’s reasoning using economic theory.

Answer. A baseball team that has committed itself to a four-year contract has made an

investment, in the hopes, of course

, of receiving a return. The cost has been “sunk,” so it

is of no relevance to any decision about how to use the player during the contract period.

The only thing of relevance is the player’s marginal revenue productivity as compared to

the marginal revenue productivity (less marginal cost to the team) of an alternative player.

2.

One recent magazine article on economic recovery from a recession argued, “Labor

productivity growth usually accelerates in the first year of an expansion, because

firms are s

low to hire new labor.” Comment.

Answer. One reason firms are slow to hire in expansions is that they are slow to lay off

workers during a recession. Workers in whom the firm has made an investment are paid

less then the value of their marginal product, so that the firm can recoup investment costs,

and this difference offers employment protection when productivity falls in a recession

(because investment costs are sunk and the firm will continue to employ a worker in the

short run as long as productivity exceeds the wage). As productivity rises during

expansion, firms will not hire workers (which involves an investment) until the gap

between productivity and wages is again large enough so that the firm can recoup

investment costs.

3.

An author recently

asserted, “Low wage jobs provide fewer hours of work than high

-

wage jobs.” Using economic theory, is this statement likely to be correct? Why?

Answer. Low wage jobs involve less training than high wage jobs, and if the training in

high wage jobs is firm-specific, employers will want to substitute longer hours of work

30

for hiring more workers. Thus, it is consistent with economic theory for employers to

require longer hours of work for workers with more skills.

31

CHAPTER 6 - SUPPLY OF LABOR TO THE ECONOMY:

THE DECISION TO WORK

Beyond introducing some descriptive material on labor force trends in this century, the

primary purpose of Chapter 6 is to present an analysis of an individual's decision

concerning whether and for how long to work. The context of this decision is the

traditional labor/leisure choice framework and the chapter is carefully constructed to

build the concepts necessary for this analysis. The analysis begins with a section that

discusses the choice process verbally, building upon what students know concerning

product demand. It then moves to a specific analysis of the demand for leisure time

(which in this context is the obverse of the supply of labor), and introduces the concepts

of income and substitution effects (they are more rigorously dealt with later in the

context of a graphic analysis).

Our graphic analysis is intended to accomplish two ends. One is to fix and define more

precisely the concepts of income and substitution effects. The second is to equip students

with a tool necessary to analyze many policy issues affecting work incentives. A

sampling of such policies and their analyses is given in the final section of the chapter

(following a section that discusses empirical findings concerning labor supply to the

economy).

List of Major Concepts

1.

Measures of aggregate labor supply generally focus on labor force participation rates

and weekly hours of work; trends in these measures are presented and discussed.

2.

The relationship between the demand for leisure, the demand for other goods, and the

supply of labor is the focal point for beginning our analysis of labor supply theory.

3.

The substitution effect is defined as the change in hours supplied attendant on a

change in the wage (price of leisure), holding income constant.

4.

The income effect is the change in hours supplied for a given change in income,

holding the wage constant.

5.

The major forces affecting labor supply are preferences, wages, and income; these

forces can be graphically depicted.

6.

The five assumptions underlying indifference curves (a graphic depiction of

preferences) are discussed.

7.

The incorporation of information on wages and income into the drawing of budget

constraints is illustrated.

8.

Graphical analyses of the income and substitution effects are presented.

32

9.

The concept of

10. Empirical findings with respect to the labor/leisure choice, from both

nonexperimental cross-section data and experimental studies, are presented.

10.

Analyses of the budget constraints created by several government income support

programs are presented. Analyzed are those with

rates (including those with work requirements), and those with positive effective

wage rates (as illustrated by an analysis of the Earned Income Tax Credit program).

Answers to Even-Numbered Review Questions

2. Evaluate the following quote: “Higher take

-home wages for any group should

increase the labor force participati

on rate for that group.”

Answer. This quotation is correct, because for labor force

participation

decisions, the

substitution effect dominates the income effect. The strength of the income effect is

relatively weaker when the initial hours of work are smaller. When initial hours of work

are zero

–

as is the case when a person is out of the labor force

–

then the income effect is

zero if leisure is a normal good (increased resources cannot induce one to increase the

consumption of leisure, since leisure hours are already at their maximum).

4. The way the workers' compensation system works now, employees permanently

injured on the job receive a payment of $$X each year whether they work or not.

Suppose the government were to implement a new program in which those who did

not work at all got $$0.5X but those who did work got $$0.5X plus workers'

compensation of 50 cents for

every hour worked

(of course, this subsidy would be in

addition to the wages paid by their employers). What would be the change in work

incentives associated. with this change in the way workers' compensation payments

are calculated?

Answer: This change in workers' compensation has two effects. First, it reduces the

subsidy for people who do not work from $$X to $$0.5X. This reduction in income by itself

would produce an income effect that tends to induce the injured worker to work more (he

or she is poorer if not working than under the previous workers' compensation system).

On the other hand, for those who work, the wage rate is increased by 50 cents an hour.

(We assume here that the change in workers' compensation payments is not so large as to

influence market wages.) The increased wage by

itself

would tend to induce injured

workers to work more because the cost of leisure has risen by 50 cents an hour; however,

the eventual outcome is theoretically unclear.

The effects of these changes can be seen in the figure below.

33

Along segment DE there is a clear-cut strengthening of work incentives. Segment DE has

a steeper slope than the previous budget constraint (BQ and it also lies to the southwest of

BC. Thus, along segment DE there is a substitution effect inducing more work and an

income effect that also induces more work. To the left of point E, however, along

segment EF, there are income and substitution effects that work in opposite directions.

Along segment EF the 50-cents-an-hour increase in the wage rate is sufficient to increase

the injured worker's income under workers' compensation, thereby creating an income

effect that reduces work incentives, other things equal. However, the substitution effect

of the increased wage continues to exert an increase in work incentives and the outcome

of the two effects is not predictable in advance.

Thus, if the tangency point between the worker's indifference curve and the full budget

constraint used to be along BC but to the right of point E, the worker faces a clear-cut

strengthening of work incentives under the new program. If, however, the worker's

tangency point along BC was to the left of point E, the new program would have an

unpredictable effect on work incentives.

6. Suppose the Social Security disability insurance (DI) program was structured so that

otherwise eligible recipients lost their entire disability benefit if they had any labor

market earnings at all. Suppose, too, that Congress was concerned about the

work

disincentives

inherent in this program, and that the relevant committee was studying

two alternatives for increasing work incentives among those disabled enough to

qualify for it. One alternative was to

reduce

the benefits paid to all DI recipients but

make no other changes in the program. The other was to maintain the old benefit

34

levels (for those who receive them) but allow workers to earn $$300 a month and still

keep their benefits. Those who earn over $$300 per month would lose all DI benefits.

Analyze the work incentive effects of both alternatives. (The use of graphic analyses

will be of great help to you.)

Answer: The proposal to reduce the average DI benefit may cause recipients to seek

work or it may not, depending on their preferences and the extent of the cut. Compare,

for example, cases a, b, and c below.

The proposal to allow DI recipients to keep their benefits until a certain earnings level is

reached will induce some of those now not working to work at least a little (case d).

Others may have preferences that preclude work (case e). However, some of those who

medically qualify for DI but would now work may decide to cut their hours of work (case

f). Thus, it is not clear from theory which proposal would have the stronger work

incentives.

8.

The Tax Reform Act of 1986 was designed to reduce the marginal tax rate (the tax

rate on the last dollars earned) while eliminating enough deductions and loopholes so

that total revenues collected by the government could remain constant. Analyze the

35

work incentive effects of tax reforms that lower marginal tax rates while keeping total

tax revenues constant.

Answer: Reducing the marginal tax rate has the effect of increasing the wage rate,

because workers are allowed to keep more from any extra hours worked. Keeping tax

revenues constant suggests that workers' after-tax incomes also remain constant. Thus,

the Tax Reform Act tended to increase the wage while keeping workers' incomes

constant -- creating a pure substitution effect that tended to increase hours of work.

Answers to Even- Numbered Problems

2. Nina is able to select her weekly work hours. When a new bridge opens up, it cuts

one hour off Nina's commute to work. If both leisure and income are normal goods,

what is the effect of the shorter commute on Nina’s work time?

Answer

. When the new bridge opened, Nina’s budget constraint shifted to the right in a

parallel fashion as the amount of available time for either work or leisure (as opposed to

commuting) was increased. This shift in her constraint created an income effect (she can

now work more

and

consume more leisure). Because both income and leisure are normal

goods, both would increase. The only way income can increase in this case is for her to

work more, so we must conclude that her extra hour per day from the shorter commute is

divided in some way between more work and more leisure. Therefore, she works more.

Suggested Essay Questions

1.

In 2002, a French law went into effect that cut the standard workweek from 39 to 35

hours (workers got paid for 39 hours even though working 35), while at the same time

prohibiting overtime hours from being worked. (Overtime in France is paid at 25%

above the normal wage rate.) (a) Draw the old budget constraint, showing the

overtime premium after 39 hours of work. (b) Draw the new budget constraint. (c)

Analyze which workers in France are better off under the 2002 law. Are any worse

off? Explain.

Answer. In the drawing below, the old (pre-2002) constraint is ABC, where slope of BC

is 25% greater (in absolute value) than the slope of AB. The constraint created by the

new law is ADE, where earnings at D are equal to those at B, and the slope of DE is

horizontal (workers cannot get paid for more than 35 hours of work).

36

Income

C

E

B

D

39 35

A

0

?

Hours of Work

close to B (that is, they worked close to 39 hours before), will also be better off if their

original utility- maximizing indifference curve passed below point D. However, for those

whose original utility-maximizing indifference curves passed above point D (almost

surely the case for most of those with original tangencies along BC), utility will fall under

the new law.

2.

Country X cuts the income tax rates applicable to those with the highest incomes, and

it newly adopts a wealth tax

–

a tax that is based on the value of family assets

(personal assets, real estate and financial assets) above a certain threshold. Discuss

the likely work incentive effects of these tax changes on high-income workers.

Answer. The new law changes the constraint from ABC to ADEF.

37

F

Income

C

E

B

D

A

?

Hours of Work

Clearly, the income tax rate reduction increases the slope of the budget constraint

(increases the net wage rate). If the wealth tax reduces a person’s overall command over

resources (which happens along segment DE), then work incentives are clearly increased

–

wages are increased while wealth falls. If the effect of the two tax changes serve to

increase both the wage rate and the command over resources (compare segment EC with

EF), then the tax changes have an ambiguous effect on work incentives, because the

substitution and income effects have opposite effects on work incentives.

38

CHAPTER 7 - LABOR SUPPLY: HOUSEHOLD PRODUCTION,

THE FAMILY, AND THE LIFE CYCLE

Chapter 7 analyzes the labor supply decision (the decision to work for pay) in the context

of household production theory. In this chapter, the primary alternative to working for

pay is not assumed to be leisure, but household production. This framework quite

naturally leads the discussion of labor supply into the context of families, thereby raising

the issue of family labor supply decisions. Further, since one's household productivity

varies considerably across the life cycle (as, of course, do wages), the concepts of

household production also lead to a discussion of labor supply over the life cycle.

Instructors facing severe time constraints may wish to skip this chapter. The insights

provided by the analysis in Chapter 7 are refinements of the basic concepts introduced in

Chapter 6, and they do not contradict the insights or predictions of Chapter 6. However,

Chapter 7 summarizes some recent directions in which labor supply theory has been

going, and to sacrifice Chapter 7 would mean forgoing concepts and empirical work

close to the frontiers of economic analysis.

The chapter begins with an introduction to the concept that households combine time and

goods to produce commodities that are consumed at home. The graphic analysis of

household production and the choice of household production technology is shown to be

completely analogous to the graphic analysis and fundamental implications of the

labor/leisure choice discussed in Chapter 6. The household production context of the

labor supply decision, however, yields insights about that decision that go beyond those

of Chapter 6. These insights are discussed after our brief introduction to household

production theory in the first section.

In particular, we point out the tripartite choice between market work, household work,

and leisure in analyzing why the substitution effects for women might be expected to be

larger than those for men. We discuss such family labor supply decisions as who stays

home to care for children (if anyone does), whether both spouses will work for pay, and

the interdependency of the spouses' labor supply decisions. The

Our discussion of the life-cycle aspects of labor supply begins with the observation that

household productivity does indeed vary over the life cycle. The traditional interrupted

careers of married women cannot be explained without reference to the shifts in

household productivity that take place when children are born and as they grow older.

Labor supply over the life cycle is also affected by the way wages typically vary with age,

causing intertemporal substitution effects; in this context, we discuss the important issue

of choice of retirement age (including data on the way lifetime Social Security benefits

vary with age of retirement).

The chapter concludes with a policy analysis of

39

List of Major Concepts

1.

The basic concepts of household production theory include the combining of goods

and time to produce commodities that yield the family utility.

2.

Household commodities may be produced by time-intensive methods or by goods-

intensive methods; the method chosen is in part a function of the price placed on time.

3.

The principal predictions associated with the income and substitution effects in the

labor/leisure model are unchanged in the context of the household production model.

The latter model, however, adds a third dimension of choice about time usage (market

work, household work, leisure).

4.

As wages change, there will be changes in the time intensity of commodities

consumed as well as in the time intensity of household production technologies.

5.

Joint household production decisions (which spouse, if either, should remain home

instead of working for pay) have yet to be completely modeled, but they must clearly

take account of the partners' marginal productivities at home and the wages they can

command in the

6.

The

discussed in the context of household production theory.

7.

Labor supply decisions over the life cycle are affected by household productivity

changes and predictable changes in wages over the life cycle that create intertemporal

substitution effects without corresponding income effects.

8.

Graphic analysis of the choice of optimum retirement age is presented, emphasizing

how delaying retirement by a year can affect the present value of one's total income

over the remaining years of expected life.

9.

Child support assurance programs ensure transfer payments to custodial parents based

on the age and number of children, not on income. In contrast with welfare programs,

which tend to create budget constraints with zero net wage rates, child support

assurance programs preserve incentives to engage in market work. However, for

those who worked for pay in the absence of such programs, the pure income effect

created by support assurance programs should tend to induce fewer hours of paid

work.

40

Answers to Even-Numbered Review Questions

2.

A recent study of the labor force participation rates of women in the post-World War

II period notes:

Over the long run women have joined the paid labor force because of a series of

changes affecting the nature of work. Primary among these was the rise of the

clerical and professional sectors, the increased education of women, labor saving

advances in households, declining fertility rates, and increased urbanization.

Relate each of these factors to the household production model of labor supply that

was outlined in Chapter 7

.

Answer: One of the central aspects of the household production model of labor supply is

the importance of the relative productivity in paid employment as compared to household

production. Increased opportunities in the clerical and professional sectors, as well as

increased educational levels, serve to increase productivity in paid employment (that is,

to increase the wage rate that women can command). Declining fertility rates tend to

reduce the productivity of hours spent at home, while the invention of labor saving

devices in household production make it easier to substitute goods purchased with cash

for time at home; both of these factors flatten the household utility isoquants (an hour of

household productivity forgone can be replaced more readily by goods purchased with

money). Increased urbanization also tended to make it easier to substitute goods for

household production. All these factors tended to raise market productivity relative to

household productivity, and some of them served to increase the strength of the

substitution effect relative to the income effect.

4.

Is the following statement true, false, or uncertain? Explain.

raise, she tends to work more.

Answer: Ignoring the question of joint labor supply decisions, if a married woman's

husband gets a raise, that raise (to her) has an income effect. This increased income

without a corresponding increase in her wage rate tends to induce her to work fewer

hours. However, if her wage rate rises, she will experience both an income and a

substitution effect, and if she already works, theory cannot predict which one is dominant.

If she is out of the labor force, a wage increase will increase her chances of labor force

participation.

The text pointed out, though, that spouses may make their labor supply decisions jointly.

For example, if the husband's wage increase caused him to work more, the wife may also

decide to work more if they are complements in household production (or consumption).

Thus, the answer to this question really depends upon whether one assumes the two

spouses have household productivities that are interdependent; if so, they must make

their labor supply decisions jointly.

41

6. Several studies have indicated that for prime-age males, the income effect of a wage

increase tends to dominate the substitution effect. Other recent studies point out that

hourly wages tend to rise over the early stages of the life cycle (the young receive

lower wages than the middle-aged)

and

that young males tend to work fewer hours

than middle-aged males, other things equal.

Employing a theory of life-cycle

allocation of time, explain the apparent discrepancy.

Answer: Studies showing that for prime-aged males the income effect of a wage increase

tends to dominate the substitution effect look either at wage increases that have occurred

as society has become wealthier and more productive or at wage rates across individuals

in a population. In both cases there are both substitution effects and income effects of

wage changes. However, studies of the life-cycle effects of lower wages in the early

stages of one's working career with higher wages later on are examining these wage-

change effects over an individual's lifetime, holding constant the individual's expected

lifetime wealth. With these studies there is a substitution effect

–

leading to more work as

wages rise

–

but no corresponding income or wealth effects. The latter studies are in the

pure life- cycle mode of analysis, where at a given time individuals have an expected

lifetime wealth and also face predictable changes in their wage rate as they age.

8.

Suppose that, under state law, the financial settlement in a divorce case that does not

involve dependent children depends upon the economic contribution each marriage

partner made up to the date of divorce. Thus, if the wife earned an income equal to

her husband's throughout the years, she would be determined to qualify for half of the

assets at the date of divorce. Based on what you have learned in Chapter 7, how could

an equitable settlement be determined in the case of a woman who stayed home,

raised the family's children, and never worked for pay?

Answer : A wife who did not work for pay nevertheless contributed to the family's

income by performing household production services that would otherwise have had to

be purchased in the market at some cost. Put differently, a woman who performs

household services saves the family money that it would otherwise have had to spend.

For a discussion of how these services can be valued, see Example 7.2.

Suggested Essay Questions

1.

Assume that a state government currently provides no child care subsidies to working

single parents, but that it now want to adopt a plan that will encourage labor force

participation among single parents. Suppose that child care costs are hourly, and

suppose the government adopts a child-care subsidy that pays $$3 per hour for each

hour the parent works, up to 8 hours per day. Draw a current budget constraint for an

assumed single mother (net of child care costs), and then draw in the new constraint.

Discuss the likely effects on labor force participation and hours of work.

Answer. If the old budget constraint is AB below, the new one will have a steeper slope

(reflecting a net wage that is $$3 per hour higher) for the first 8 hours of work (see AC);

42

after that, the budget constraint is segment DB. Among those single parents not working

before the subsidy is adopted, the higher wage rate will tend to increase labor force

participation (the substitution effect dominates for participation decisions). For those

already working (tangencies along AC), the income effect and substitution effects of this

wage increase will have opposite tendencies on the hours of work, so the net effect is not

predictable. However, some people working over 8 hours a day before may reduce their

supply of hours and move to point C on the constraint.

Income

B

D

C

8

A

?

Hours of Work

2.

Assume that a state government currently provides no child care subsidies to working

single parents, but that it now want to adopt a plan that will encourage labor force

participation among single parents. Suppose child care costs are hourly, and that the

government adopts a child-care subsidy of $$20 per day if the single parent works 6 or

more hours per day. Draw the current budget constraint (net of the hourly child care

costs) for an assumed single mother, and then draw in the new constraint. Discuss the

likely effects on labor force participation and hours of work.

Answer. In the drawing below, the pre-subsidy constraint is AB. The subsidy of $$20

per day (CD) begins at 6 hours of work and continues for all levels of work hours beyond

6 (segment DE, which is parallel to AB). Thus, the new constraint is ACDE. Those

single parents who were out of the labor force before (maximized utility at A) and who

have very steep indifference curves will tend to remain at point A; however, those with

flatter indifference curves will find that their utility is maximized at point D. Thus, some

workers who were out of the labor force before will now join, and those who do will

43

desire jobs offering exactly 6 hours of work per day. For those along AC before

(working less than 6 hours per day), the tendency also will be to move to 6 hours of work

(although it is possible that some will have such a steep indifference curve to the left of

their tangency along segment AC that they will not be better off by working 6 hours).

For those working more than 6 hours per week before, the income effect of this subsidy

will create a tendency for them to desire fewer hours of work (as long as the hours do not

fall below 6).

Income

E

B

D

C

A

6

?

Hours of Work

44

CHAPTER 8 - COMPENSATING WAGE DIFFERENTIALS AND

LABOR MARKETS

Chapter 8 introduces students to the concept of compensating wage differentials.

Following the practice in earlier chapters, it seeks to move students from concepts they

are familiar with to new concepts and tools. Again, the analysis begins with a

verbal

exposition of occupational choice and the wage outcomes that flow from this choice

when jobs differ along nonpecuniary dimensions. Once the essential assumptions and

predictions of economic theory in this context are explained, we introduce students to a

graphic analysis that is intended to yield additional insights. The graphic analysis of the

issue of occupational choice is also intended to provide students with a tool for analyzing

the effects of government policies on the labor market.

We first apply the concepts of hedonic theory to a

are related to occupational safety and health legislation. We then apply the theory to an

analysis of how elements in the employment

positive

value affect the wage rate. The application in this section of the chapter relates to

the regulation of employee benefits, particularly pensions.

For those who wish to enrich the coverage in Chapter 8, we have added an appendix that

analyzes worker choice of jobs that have different probabilities of layoff. This appendix

offers another application of the theory of compensating wage differentials to an

interesting policy problem, and in so doing elucidates certain issues not commonly

understood. The analysis also introduces the student to the notions of

the willingness to pay for insurance (

List of Major Concepts

1.

In the context of full information and choice, worker behavior will generate

compensating wage differentials for job characteristics that are unpleasant or costly.

2.

Compensating differentials play a dual role in allocating labor to unpleasant jobs and

in compensating those who accept unpleasant work.

3.

The prediction that there will exist compensating wage differentials for unpleasant

work rests on assumptions of utility maximization, worker information, and worker

mobility.

4.

Employee preferences are graphically expressed in the concavity and slope of

indifference curves.

5.

Employers with different costs of eliminating unpleasant job characteristics can be

graphically represented.

6.

A market equilibrium curve (or offer curve) is derived from the zero-profit isoprofit

curves of the employers in the market.

45