Questions - Johan Lindén, Mälardalens högskola



Chapter 11Markets for Factors of ProductionQuestionsHow do firms estimate the demand for labor?Answer: The value of the marginal product of labor (VMPL) is the demand for labor for a competitive firm. The marginal product of labor is the additional output that is produced by employing an additional worker. According to the law of diminishing returns, the marginal productivity of an additional unit of labor decreases as the quantity of labor is increased. The value of the marginal product of labor equals the marginal product of labor times the price of output. The labor demand curve is downward sloping due to the law of diminishing returns. How does the labor-leisure trade-off determine the supply of labor? Answer: Non-work activities are labeled “leisure.” Time that is not spent on leisure will be spent on work. So, the price of leisure, in terms of its opportunity cost, is the lost wages from not working. Individuals would consume leisure up to the point where the marginal benefit from leisure equals the marginal cost, where the marginal cost is the wage rate. Use the concepts discussed in this chapter to explain how a company like The Wisconsin Cheeseman can maximize its profits.Answer: According to the text, there are two ways in which a firm (like The Wisconsin Cheeseman) can maximize its profits—by expanding the production until marginal cost equals the market price; or by expanding its workforce until the marginal product of labor x price equals the market wage.We showed above that a profit-maximizing firm will hire the number of workers such that the wage is equal to the value of the marginal product of labor. But, as the text showed in an earlier chapter, a profit-maximizing firm will produce the quantity of output such that price equals marginal cost. Are these two rules inconsistent?Answer: No. To see this let p = price of output, MPL = marginal product of labor, w = wage rate, VMPL = value of the marginal product of labor, and MC = marginal cost. To see that there is no inconsistency, note the following:Firms maximize profits by producing the level of output such that price equals marginal cost and therefore p = MC.Firms maximize profits by hiring the number of workers such the wage rate equals the value of the marginal product of labor and therefore w = VMPL.By definition the value of the marginal product equals the price of output times the marginal product of labor and therefore w = p x MPL, which implies p = w / MPLMC must equal w / MPL. If a firm wants to produce one more unit of output it would need to hire 1 / MPL additional workers. So, for example, if the MPL is 2 then a firm would have to hire half an additional worker to produce one more unit of output. The cost of these additional workers is w / MPL, which is the cost of producing one more unit of output.Therefore if a firm follows the w = VMPL rule in its hiring decision it will also follow the p = MC rule in its output decision.Consider an industry employing skilled technicians and low-skilled workers together with machines to produce a good. A new technology comes along that performs the low-skill tasks, but needs more maintenance. How would the adoption of this technology affect the following?The wage for skilled technicians A firm’s demand for low-skilled workers Suppose the market price of the product increases. How would this affect the equilibrium in the labor market? Answer: The wage for skilled technicians will rise. The new technology is skilled-labor-complementary. The adoption of the new machines increases the need for servicing and maintenance, which increases the demand for skilled technicians. A firm’s demand for low-skilled workers will fall because the new technology is unskilled labor-saving. Fewer of them will be needed to complete the same task for a given level of capital, since some of them can be replaced by the new technology.The rise in the market price of the product increases the VMPL for both skilled technicians and low-skilled workers. The equilibrium wage and level of employment for skilled technicians will rise. For low-skilled workers, the cumulative effect is ambiguous and depends on the relative effects of the introduction of labor-saving technology and rise in the market price of the product. Suppose wages in the market for plumbers increase. Some plumbers start taking on extra plumbing jobs while others cut back on the number of hours they work. What could explain these two responses? Answer: An increase in wage has an income effect and a substitution effect. The substitution effect implies that when the price of leisure increases, people will work more (and relax less). The income effect implies that when wages increase, total income increases and more expensive things, like leisure time, become more affordable. Hence, the income effect will cause people to work less after a wage increase. While an increase in wage leads to both these effects, the income effect is likely to have been stronger for plumbers who cut back on the number of hours that they worked while the substitution effect is likely to have been stronger for those plumbers who decided to work more. How do labor-saving technologies differ from labor-complementary technologies? Give an example of each. Answer: Labor-saving technology is a type of technology that can substitute for existing labor inputs, reducing the marginal product of labor. Labor-complementary technology is a type of technology that can complement existing labor inputs, increasing the marginal product of labor. Computers that displace workers on an assembly line in a factory are examples of labor-saving technology. A word-processing program is an example of a labor-complementary technology as it improves the productivity of secretaries or administrative assistants.Last year, chief executive officers (CEOs) of large companies earned 354 times the salary of the average worker. Why do companies pay so much to hire a CEO? Why do CEOs get paid so much more than junior managers?Answer: The wages that are paid to CEOs and junior managers depend on each person’s ability to produce labor of economic value. Compared to junior managers, CEOs add a greater economic value to the firms that hire them, in terms of directing its operations, planning its strategy, and managing the business and its employees. Thus, the VMPL of a CEO is higher, and is compensated for by a high wage. Therefore, companies pay such large amounts to hire a CEO. On the other hand, a CEO’s position requires a high degree of specialized skill, and there are fewer candidates with the necessary skills to become a CEO than there are potential junior managers. At the margin, the last junior manager hired adds less to output than does a CEO, as measured by her contribution to total revenue. Therefore, CEOs get paid much more than junior managers.In developing countries, working as a miner is riskier than working as a security guard. You are the manager of a mining company, and you wish to hire one miner and one security guard. Given the candidates with the same level of education and other attributes, which type of worker would you offer a higher wage, and why?Answer: I would offer the miner a higher wage than the security guard. This is because of two reasons. First, the miner has a more specialized skill than the security guard. Fewer workers have the training required to be miners, and thus they command a skill premium. Additionally, mining is more risky to life and health. High-risk occupations attract those workers who are willing to bear an occupational risk in return for a higher wage. Therefore, I would offer a miner a higher wage than I would a security guard.What is the difference between statistical and taste-based discrimination? The owner of a company that manufactures automobile parts states that it will not hire gay or lesbian employees. Is this an example of statistical or taste-based discrimination? Answer: Employers that practice taste-based discrimination are willing to forego profits. Employers engaging in statistical discrimination, however, are trying to enhance their profits. The refusal to hire a gay employee is almost surely an example of taste-based discrimination. It would only be statistical discrimination if sexual orientation contained information about the employee’s ability to do the job – and information beyond what could readily be inferred from resumes, work experience, and job referrals. Around the world, the wage premium for a skilled worker over a low-skilled worker has been rising rapidly in the past two decades. Some commentators blame the widespread adoption of computerized machines that require more training before use. In your view, are they correct? Explain your answer. Answer: There are many factors behind the rising wage premium for skill of recent years. The growing use of computerized machines is one of them. As technology improves, and is used more widely, the value of workers who can operate complicated machines increases. These skills are at a premium, as more training is required before use. Thus, such workers can command a higher wage. At the same time, workers who are of low skill often find themselves replaced. Moreover, low-skilled workers are abundantly available. Thus the wages of the latter remain low, and the gap between the two increases. Use the concepts studied in this chapter to explain the main source(s) of wealth accumulation over time.Answer: In the 1910s and 1920s, very wealthy individuals earned most of their income from capital and ownership of businesses, while the mega-rich of today derive the majority of their income from labor.Suppose an identical tax is levied on capital, labor, and land. Would the tax have the same effect in each of these markets? Explain your answer. Answer: The effect of the tax would depend on the relative elasticities of supply and demand for land, labor, and capital. A tax on land falls mostly on landowners because the supply of land is very inelastic (land does not have an alternative use). Since capital the supply of capital is very elastic, a tax on capital falls largely on demanders. The effect of a tax on labor will depend on whether the supply or demand for labor is more elastic. If the demand for labor is inelastic, firms will bear a higher proportion of the tax. On the other hand, if the supply of labor is inelastic, workers will bear a higher proportion of the tax. The available empirical evidence suggests that the supply of labor is less elastic than demand. As a consequence, economists believe that workers bear most of the burden of a tax on labor.ProblemsConsider the following information for a textile manufacturer operating in a perfectly competitive market: MP = 100 ? L, output selling price is $20 per unit, and wage is $100 per worker. Find the profit-maximizing number of workers for this textile manufacturer.Answers:The manufacturer should equate the value of the marginal product of labor with the wage rate. This means that it will hire 95 workers to maximize its profits.20 × (100 – L) = 1002000 – 20L = 10020L = 1900L = 95.You accept a new job for a wage of $30,000 at a newspaper. You join the sales team, which consists of 10 people that try to sell online subscriptions. Each subscription sells for $200. When you talk to your boss, she says that you are the 11th worker, and that if you had not joined the team, she would have done okay with just 10 people -- but “great to have you, we are more productive with you on board!” If your boss is a smart person who has studied economics, what must she believe about the number of online subscriptions that you will help the team sell?Answer: She must believe that you will increase sales by at least $30,000 / $200 = 150. (This is a reworking of the profit-maximizing condition MPL*price = wage.) Anything less than 150 and she would not have hired you. Also, anything significantly more than 150 and she would probably try to hire a 12th worker as well. (This all assumes the wage of $30,000 is determined by market forces outside of your boss’s control.) A friend tells you that he thinks that the salesmen who work at Apple stores are paid very low wages, given their productivity. Dividing Apple’s revenues by the total number of employees shows that each employee contributed to an average of $473,000 in revenues in 2011. But, most of Apple’s sales staff are paid about $25,000 a year. What is the flaw, if any, in your friend’s reasoning? Answer: Your friend is incorrect because the wage that is paid to labor does not depend on the average revenue per employee. In a competitive market, the wage that is paid to a worker will be equal to the value of his marginal product, not the average contribution of all employees in the firm. Apple sales people might be willing to work for a low wage because they enjoy working with technology; that is, the low wages reflect a compensating differential. Combined with the fact that the job is not likely to require a high level of skills or specialized training, the firm can afford to pay wages that are considered low. See following table shows the average salary for first-team football players in sport leagues around the world. The average salary in Great Britain is nearly 16 times larger than the average salary in Scotland.Sport leagueAverage salaryEPL, Great Britain$3,218,523La Liga, Spain$1,635,869Serie A, Italy$1,459,436Bundesliga, Germany$1,372,610Ligue 1, France$961,638CSL, China$775,358MLS, North America$313,438J-League, Japan$211,880SPFL, Scotland$193,907Explain what economic forces will encourage football players in Scotland to play an extra year compared to those in Great Britain. Are there any economic reasons for Great Britain’s football players to retire earlier than those in Scotland?Answer: A player will choose to play one more year if the value of an extra year of leisure is less than the wage he could earn by playing. Since the major league salaries have increased so significantly, the opportunity cost of leisure has risen and some players will therefore choose to play another year. This is similar to the substitution effect discussed in the text.Players in Great Britain are much wealthier because wages are much higher than they are in Scotland. If leisure is a normal good, some players will choose to use some of their additional wealth to increase their consumption of leisure by retiring earlier. This is similar to the income effect discussed in the text.See A textiles manufacturer specializing in flower embroidery pays its workers a wage of $10 per hour, with each worker working 40 hours and embroidering 120 flowers per week. A wedding planner has just signed a contract with the manufacturer, ordering material embroidered with 200 flowers. The manufacturer now needs to have a 45 hours’ workweek in order to meet this demand. She considers two cost strategies: the first one is to introduce an hourly overtime payment of $12, and the second one is to raise the wage at $11.56 per hour. Both strategies have the same cost of $520. Which strategy is more likely to lead the employees to agree to extra work per week?Answer: The first strategy, because the substitution effect is much larger. Under the first strategy, they will weigh the benefits against the over-time wage of $12. Under the second strategy, workers will weigh the benefits of an additional hour of leisure against the offered wage of $11.56. Some workers might actually choose to work less under the second strategy because of the income effect of a wage increase.Sketch a typical looking labor market with a downward sloping aggregate VMPL (labor demand). Label the part of this VMPL curve that maximizes total productivity.Label the part of this VMPL curve that maximizes average productivity (i.e., output per worker).Add an upward sloping labor supply. Label the intersection with the VMPL curve. Explain why economists believe that this spot is best (efficient).Add a binding minimum wage (price floor). Has the minimum wage increased or decreased worker productivity? Briefly explain.Answers:At point labeled by “a”, the total productivity is maximized; any point beyond this and workers do not increase productivity at all. This also corresponds to maximum useful employment. (And the value of the total product is captured by the area of the triangle under the VMPL curve.)At “b” we have (approximately) one worker. Here the graph is only an approximation, though the main point holds: When VMPL is downward sloping everywhere, maximum per-worker productivity is achieved with just one worker.The point at “c” is efficient because the value of the marginal product of the last worker is equal to the marginal cost for this worker. In other words, a firm may be able to produce $50 more with extra help, but this is only worthwhile if this person values their time at less than $50.As shown by “min wage”, the marginal product (and thus also the average product per worker) is higher with a binding minimum wage. The firm responds to the wage floor by cutting back employment, which ensures that the last worker hired is worth as much as the new, higher wage.The Patient Protection and Affordable Care Act (ACA) requires all employers with at least 50 full-time equivalent workers to offer health insurance to their full-time employees or pay a fine of up to $2,000 per employee (see for a description of the ACA). Some people have argued that ACA will lower employment. This problem looks at an important issue in this debate.Suppose the government passes a law that requires firms to offer health insurance to their workers. The cost of the insurance is equal to $1 for each hour an employee works. How will this law affect firms’ demand for labor? Suppose workers consider a dollar of health insurance paid by firms to be the equivalent of $1 in wages. How will this law affect the supply curve of labor? Consider an industry where the equilibrium wage is $15 per hour and 100 workers are employed. How will this law affect the equilibrium quantity of labor in this labor market? How will it affect the equilibrium wage in this industry? Now suppose workers consider a dollar of health insurance paid by firms to be worth less than $1 in wages. How will this law affect the equilibrium quantity of labor in this labor market? How will it affect the equilibrium wage in this industry? Answer:This law is equivalent to a $1 tax on employers. It will therefore shift employers’ demand curve for labor down by $1.If workers consider a dollar of health insurance paid by firms to be the equivalent of $1 in wages, this law provides a $1 subsidy for labor. The law will, therefore, shift the supply curve for labor down by $1.The supply and demand diagram below is helpful in understanding this problem. If workers consider the value of a dollar of health insurance paid by firms to be the equivalent of $1 in wages, the equilibrium wage will fall to $14 per hour and the equilibrium quantity of labor will be unchanged. Workers receive total compensation (including the value of their health insurance) of $15, just as they did before this act was passed. Employers pay a total of $15 (including the cost of the health insurance), just as they did before this act was passed. So, the equilibrium quantity of labor is the same at 100 workers. At this level of employment, the quantity of labor demanded at $15 is equal to the quantity supplied at $15. The equilibrium quantity of labor and the equilibrium wage will both fall. To see this, consider the extreme case where workers place no value on health insurance provided by their employers. In this case, the supply curve does not shift but the demand curve shifts down by $1. The decrease in demand lowers the equilibrium wage and the equilibrium quantity of labor.Joey, Mandy, and Jim have the following labor supply (hours per day, based on hourly pay).WageJoeyMandyJim$5402$10846$151289Who values their time more, Joey, Mandy, or Jim (or is there not enough info to say)?What is total labor supply given a wage of $15?What if the demand for labor were fixed at 18 (i.e., firms wanted a total of 18 hours per day, regardless of wage). What would the equilibrium wage?Answers:Mandy values her time the most since she is willing to supply the least amount of labor for any given wage.12 + 8 + 9 = 29 total hours will be supplied at a wage of $15.A wage of $10 would bring the market into equilibrium since at wage = $10, the total supply of labor is exactly 8+4+6 = 18.You run a factory that uses pottery wheels to make pots. You can hire anywhere between 1 and 3 skilled artisans (workers), and you can rent 1 or 2 pottery wheels (machines). Pots sell for $100 each. The total product of your factory (per day) is shown in the following table.Number of Workers (Labor, L)123Number of Machines (Capital, K)16911281215Given one machine and one worker, how much would you be willing to pay to hire a 2nd worker? (Consider the value of the marginal product of labor.)Again starting from one machine and one worker, what rental rate would you be willing to pay to acquire a 2nd machine? (Consider the value of the marginal product of capital.)Suppose wage is $250 (per day). How many workers would you hire if you have one pottery wheels? How many workers would you hire with two pottery wheels?Are pottery wheels labor saving or labor complementary?Answers:You would be willing to pay up to $300 since the marginal product of a 2nd worker is 9-6=3, and each pot sells for $100, so VMPL = $300.You would be willing to pay a rental rate of up to $200 since the marginal product of a 2nd machine is 8-6=2 and each pot sells for $100, so VMPK = $200.With one pottery wheel: wage = $250 implies you want a 2nd worker but not a third since the third worker has marginal value of only $100(11-9) = $200 < $250. With two pottery wheels, a third worker is worth it since $100(15-12) > $250.Pottery wheels are labor complementary since they increase the marginal product of labor: For the second worker (12-8) > (9-6) and for the third worker (15-12) > (11-9).For Acme Manufacturing, the marginal product of labor is MP = 10 – 2L. Acme sells its output for $10 per unit.Sketch the value of the marginal product of labor (VMPL). How many workers will Acme hire given a wage of $40?Repeat, but after the output price increases to $20 per unit. Does this change induce Acme to hire more or fewer workers?Answers:VMPL = ($10)(10 - 2L) = 100 - 20L. Setting this equal to wage of $40 yields L = 3.VMPL = ($20)(10 - 2L) = 200 - 40L. Setting this equal to wage of $40 yields L = 4. So the increase in the price of the output induces Acme to scale up operations and hire another worker (more workers). ................
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