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PERECON  REVIEWER  

CHAPTER 2
5. From Table 2.2, the CPI (with a base of 100 in 1982–1984) rose from 130.7 in 1990 to 201.6 in 2006.
The federal minimum wage (nominal hourly wage) in 1990 was $3.80, and it was $5.15 in 2006. Calculate
the minimum wage in real (1982–1984) dollars. Did the federal minimum wage increase or decrease in real
dollars from 1990 to 2006?

Answer:
Real hourly minimum wage in 1990 = nominal wage in 1990/CPI in 1990
= ($3.80/130.7) * 100
= $2.91
Real hourly minimum wage in 2006 = nominal wage in 2006/CPI in 2006
= ($5.15/201.6) * 100
= $2.55
The federal minimum wage decreased in real dollars from 1990 to 2006.
7. From the original demand function in Problem 6 (see table), how many cashiers would have jobs if the
wage paid were $8.00 per hour? Discuss the implications of an $8 wage in the market for cashiers.

Answer:
If cashiers are being paid $8.00 per hour, they are being paid more than the market equilibrium
wage for their job. At $8.00 per hour, employers will hire 110 cashiers, but 175 workers are available
for work as a cashier. There are 65 workers who would like a job as a cashier at a wage of $8.00 per
hour but cannot get such a job. Because a labor surplus exists for jobs that are overpaid, a wage
above equilibrium has two implications. First, employers are paying more than necessary to produce
their output; they could cut wages and still find enough qualified workers for their job openings. In
fact, if they did cut wages, they could expand output and make their product cheaper and more
accessible to consumers. Second, more workers want jobs than can find them. If wages were reduced
a bit, more of these disappointed workers could find work.

Answer: (Appendix) As the chapter explains.PERECON  REVIEWER   CHAPTER 3 1. Suppose that the supply curve for lifeguards is LS = 20 . Graph both the demand and supply curves. and MPK = 10 K-0.75 L0. from $4 to $3 5. Now. listening. suppose that the government imposes a tax of $1 per hour per worker on companies hiring lifeguards. If the Tennessee study can be generalized. and L = hours of labor.25 L-0. Suppose that there is a school that had 90 third graders taught by four teachers that added two additional teachers to reduce class sizes. (Appendix) The Hormsbury Corporation produces yo-yos at its factory. 3. Since the supply curve is vertical. and the demand curve for lifeguards is LD = 100 . Wages are $12 per hour. the workers will bear the entire tax. Determine the cost-minimizing capital-labor ratio at this firm.25 L0. How will this tax affect the wage of lifeguards and the number employed as lifeguards? Answer: See the figure below. math.75. where C is the rental cost of capital. what is the marginal product of labor (MPL ) of these two additional teachers? Answer: The marginal product (as measured by these test scores) is 0. the firm picks K and L so that W/MPL = C /MPK .75 3 = 3K/L K= L .20W.25L-0. The wage will fall by $1 per hour. The production function is q = 40 K0. to minimize cost. Therefore MPL = 30 K0. Rearrange this W /C = MPL /MPK and substitute in the information from the problem: 12/4 = 30K0.75L0.25/ 10K-0. Draw the new (after-tax) demand curve in terms of the employee wage. where L = the number of lifeguards and W = the hourly wage. and word study skills were the same in small classrooms (13 to 17 students) as in regular classrooms (22 to 25 students). K = hours of yo-yo equipment used. where q = boxes of yo-yos per week.25. An experiment conducted in Tennessee found that the scores of second graders and third graders on standardized tests for reading. Both its labor and capital markets are competitive. and yo-yo-making equipment (a computer controlled plastic extruding machine) rents for $4 per hour.75.

Union B faces a demand curve in which a wage of $6 per hour leads to demand for 30. K = hours of equipment used. including the bargaining power of the two unions and the firms with which they deal. however. and this is likely to reduce its incentive to push for large wage gains.0. (Appendix) Creative Dangles is an earring design and manufacturing company.000 to 33. a wage decrease from $6 to $5 (a 16% decrease) is associated with an increase in employment from 30.000 person-hours. Costs are minimized when MPL /MPK = W /C. The elasticity of demand is defined as the percentage change in employment divided by the percentage change in the wage.625. Workers are paid $8 per hour. a. It is true. Using the starting values for employment and wages as our bases. Pick K and L so that (MPL /MPK ) = W /C.000 pairs of earrings. The production function for earrings is Q = 25 KL. and L = hours of labor.000 .000 person-hours. that the union with the more elastic demand curve will suffer a larger percentage employment loss for any given percentage increase in wages. . or (25K /25L ) = 8/8 = 1. capital is substituted for labor. What is the new cost-minimizing capitallabor ratio? Answer: a.20. How much does it cost to produce 10.2. Once capital becomes cheaper. Which union will be more successful in increasing the total income (wages times person-hours) of its membership? Answer: a. a. This depends upon a number of factors.33.50%/25% = . Determine the cost-minimizing capital labor ratio at this firm. Union A faces a demand curve in which a wage of $4 per hour leads to demand for 20. the elasticity of demand for A’s members is . The elasticity of demand facing B is therefore 10%/. The demand curve facing A is more elastic than the one facing B. whereas a wage of $5 per hour leads to demand for 33.000 person hours. b. meaning that the capital-labor ratio rises from 1 to 1. and a wage of $5 per hour leads to demand for 10.000 person-hours. b.000—or a 50% decrease in employment. the calculation is as follows: c. the percentage change in employment of Union A’s members when the wage rises from $4 to $5 (a 25% increase) is (10.000)/20. Thus. One cannot say which union will be more successful in increasing its members’ total earnings.PERECON  REVIEWER   7. the firm should use equal amounts of capital and labor. K /L must now equal 8/6. For Union B. where Q = pairs of earrings per week.16% = . Which union faces the more elastic demand curve? b. the union facing the less elastic demand curve is likely to be more successful in raising its members’ wages.000—a 10% increase. To produce 10. Suppose the rental cost of equipment decreases to $6 per hour. MPL equals 25K. Since the cost-minimizing capital-labor ratio is 1. and MPK equals 25L . and the equipment rents for $8 per hour. so their ratio equals K /L. b. For costs to be minimized. Thus.000 pairs of earrings? c. CHAPTER 4 5.

) b. The supply of labor is given in the following table for Teddy’s Treats.2E . which is a profit-maximizing monopsonist. the wage must rise by 20 cents for every one person increase in desired number of employees.PERECON  REVIEWER   CHAPTER 5 1. a. Express the marginal expense of labor (MEL ) incurred when hiring an additional worker.2E2 . Answer: a. Suppose a firm’s labor supply curve is E = 5W . b. E = 5W. . Solve for the hourly wage that must be paid to attract a given number of workers (E ) to the firm. Thus.2E ) = 0. b. Draw the supply of labor curve and the marginal expense of labor curve Answer: a. 5. Total labor costs (C ) are E·W. c. The marginal expense of labor is equal to Δ (total labor cost)/Δ (supply of labor).4E . so C = E (0. b. the marginal expense of labor rises by 40 cents (refer back to footnote 7 in the text). (See the following table. Note that while wages must rise by 20 cents for every additional employee desired. a dog biscuit company. Express the total hourly labor cost associated with any given level of employment. The marginal expense of labor (MEL ) is found by taking the derivative of C with respect to E : dC /dE = 0. a. so W = 0. Calculate the total labor cost and the marginal expense of labor for each level of employment. The total labor cost is equal to the offered wage * supply of labor. where W is the hourly wage. c.

At Toasty Tasties. the offered wage. d. Calculate the marginal expense of labor. What would happen if some nonmarket force were to compel the firm to pay its employees an hourly wage that is larger than $26 per hour? Answer: a. e. there will be an increase in the number of hours employed to 9 hours. c. Draw the supply of labor. If the mandated wage is $14 per hour. there will be 8 hours of labor employed. c. . What would happen if some nonmarket force were to compel the firm to pay its employees $14 per hour? e. b.PERECON  REVIEWER   9. a restaurant that specializes in breakfast and lunch. b. 8 hours of labor will be employed at a wage of $12 per hour. there will be fewer than 8 hours of labor employed. f. and the MRPL at Toasty Tasties. the marginal expense of labor. and the MRPL curves at Toasty Tasties. The following table gives the quantity of labor. To maximize profits. how many hours of labor should be hired? What wage will the employer offer? d. a. The profit-maximizing firm will determine the quantity of hours by equating MEL with MRPL and offer a wage as indicated by the supply of labor curve. If the mandated wage is $26 per hour. If the mandated wage is above $26 per hour. What would happen if some nonmarket force were to compel the firm to pay its employees $26 per hour? f.

their initial indifference curve was tangent to the initial budget constraint (line ACE) at point C .10) (50) = 500 Income Effect = (ΔH /ΔY )|W (constant) = . where W= the hourly wage. Assuming that this 50 percent overtime pay premium is newly required for all work beyond eight hours per day. total earnings remain the same. After the new law is passed. b. a. The new earnings formula is 8W +2 * 1. and the substitution effect always pulls in the direction of less leisure whenever the wage rate has risen. you work 1 hour less each year. What is the substitution effect associated with this lottery win? Explain. (Income in the vicinity of point C is effectively being held constant. Calculate the annual income effect from this lottery gain based on a 50-week year. b. See the figure above. where the initial budget constraint is given by ACE. many employers tried to avoid it by cutting hourly pay so that total pay and hours remained the same.) 3. . and hours of work must increase—tangency points along CD lie to the left of point C. Instead. b. Pick W so that this total equals $110.500/50000 = . Thus. Suppose you win a lottery.PERECON  REVIEWER   CHAPTER 6 1. What hourly base wage will the employer offer so that the total pay for a 10-hour workday will stay the same? c. the workers’ initial indifference curve cannot be tangent to the new constraint at point C. the new wage rate and overtime constraint is given by ABCD .1/100 Interpretation: For every $100 increase in non-labor income. Answer: a. a. See the following figure. we calculate that W = $10 per hour. When the Fair Labor Standards Act began to mandate paying 50 percent more for overtime work. Will employees who used to work 10 hours per day want to work more or fewer than 10 hours in the new environment (which includes the new wage rate and the mandated overtime premium)? Answer: a. If the workers were initially at a point of utility maximization. draw a budget constraint that pictures a strategy of cutting hourly pay so that at the original hours of work.000 per year until you retire. Δ hours worked per year = Δ hours worked per week * weeks worked per year = (. c. Since the new budget constraint (along segment BD) has a steeper slope ($15 per hour rather than $11 per hour). earnings were $11 * 10 = $110. and your after-tax gain is $50. As a result. Interpret the results in light of the theory presented in this chapter. you decide to work part time at 30 hours per week in your old job instead of the usual 40 hours per week. the budget constraint bends upward after 8 hours of work. Initially. there will be a new point of tangency along segment CD. Suppose that an employer initially paid $11 per hour and had a 10-hour workday. Since 11W = $110. which intersects the old constraint at point C —the original combination of income and working hours (10 hours of work in this example).5W .

Suppose Michael receives $50 per day as interest on an inheritance.$145)/(9 . His overtime wage rate is ($325 .PERECON  REVIEWER   b.$75)/(16 . Answer: 7. and he can work a maximum of 16 hours per day at his job. 5. Teddy’s employer pays him a base wage rate plus overtime if he works more than the standard hours. Teddy’s daily budget constraint is shown in the following chart. His wage rate is $20 per hour.0) = $180/9 = $20 per hour. . income is increased without a change in the compensation received from an hour of work. Thus. The lottery win enhances wealth (income) independent of the hours of work. What is Teddy’s daily nonlabor income? What is Teddy’s base wage rate? What is Teddy’s overtime wage rate? How many hours does Teddy need to work to receive overtime? Answer: Teddy’s non-labor income is $75. Teddy needs to work at least 7 hours before he receives overtime. His base wage rate is ($145 . The substitution effect is zero.9) = 70/7 = $10 per hour. Draw his daily budget constraint.