Labour Economics (BSc) – Academic year 2019-2020, Retake session

Instructors: Costanza Naguib and Michele Pellizzari

Teaching Assistant: Clemente Pignatti

Instructions: You have 2 hours to complete the exam. There is only one correct answer for each question. You obtain

a point of 1 for each correct answer and a penalty of -0.25 for incorrect answers. Good luck with the exam!

SHORT QUESTIONS

1. What is the fundamental problem of causal inference?

(a) We cannot observe the same unit being treated and untreated at the same time

(b) The parallel trend assumption might not hold in certain circumstances

(c) Treatment intensity might be too small to detect any effect

(d) Different units might respond differently to the same treatment

Solution: Correct answer is a.

2. Which of the following is not a necessary condition for consistency of the OLS estimator?

(a) The data are random sample from the population of interest

(b) The model is linear in parameters

(c) No perfect multicollinearity among covariates

(d) E(u | X) = 0

Solution: Correct answer is d.

3. The model of taste-based discrimination (Becker, 1975) is built on the premise that:

(a) Discrimination allows employers to detect high productivity workers

(b) Individuals have a preference for some groups and an aversion towards others, even when these groups are

equally productive

(c) Firms have limited information on workers’ productivity and use observable characteristics (e.g. race, gender)

to infer their ability

(d) Employers offer equal wages to workers of equal productivity in order to maximise profits
Labour Economics (BSc) Academic year 2019-2020

Solution: Correct answer is b.

4. In a perfectly competitive economy, does immigration reduce employment of the natives?

(a) Always

(b) Never

(c) Only if immigrants are substitutes to natives

(d) Only if immigrants are complements to natives

Solution: Correct answer is c.

LONG QUESTIONS

1. Consider an individual whose preferences are described by U = C 1/2 + L1/2 , where C denotes consumption and

L corresponds to leisure. The average price of the consumption good is p = 2, the hourly wage is w = 4 and the

amount of available time is T = 24. The individual has no source of non-labour income (v = 0).

(a) What are the vertical and horizontal intercepts of the budget constraint if we place consumption of the y

axis and leisure on the x axis?

(a) Vertical intercept: 24; Horizontal intercept: 48

(b) Vertical intercept: 48; Horizontal intercept: 48

(c) Vertical intercept: 48; Horizontal intercept: 24

(d) Vertical intercept: 24; Horizontal intercept: 24

Solution: The correct answer is c.

(b) What is the slope of the budget constraint?

(a) 2

(b) -2

(c) 1

(d) -1

Solution: The correct answer is b.

(c) Everything else being equal, indifference curves will be steeper for an individual that:

(a) Places high value on an extra hour of leisure

Labour Economics (BSc) Academic year 2019-2020

(b) Places low value on an extra hour of leisure

(c) Has a steep budget constraint

(d) Has high non-labour income

Solution: The correct answer is a.

(d) What is the optimal amount of consumption, leisure and hours worked (H) chosen by the individual?

(a) L=8, C=32, H=16

(b) L=8, C=24, H=16

(c) L=12, C=32, H=12

(d) L=0, C=32, H=24

Solution: The correct answer is therefore a.

(e) Assume that the individual now earns non-labour income v = 6. Derive the vertical and horizontal intercepts

of the new budget constraint

(a) Vertical intercept: 51; Horizontal intercept: 24

(b) Vertical intercept: 51; Horizontal intercept: 25.5

(c) Vertical intercept: 54; Horizontal intercept: 24

(d) Vertical intercept: 54; Horizontal intercept: 25.5

Solution: The correct answer is therefore a.

(f) Derive the new optimal amount of consumption, leisure and hours worked (i.e. taking into account the

presence of non-labour income)

(a) L=8, C=32, H=16

(b) L=8.5, C=32, H=15.5

(c) L=8.5, C=34, H=15.5

(d) L=8, C=34, H=16

Solution: The correct answer is c.

(g) How would you interpret the result on labour supply obtained in point (f) in terms of income and substitution

effects?

(a) The income effect leads to a reduction in labour supply, while the substitution effect has the opposite

effect. The income effect prevails

(b) The income effect leads to a reduction in labour supply, while the substitution effect has the opposite

effect. The substitution effect prevails

Labour Economics (BSc) Academic year 2019-2020

(c) The income effect leads to a reduction in labour supply, while there is no substitution effect

(d) The income and substitution effect perfectly compensate each other

Solution: The correct answer is c.

(h) What is the minimum level of non-labour income that would induce the individual to withdraw from the

labour market (i.e. H=0)?

(a) v=186

(b) v=188

(c) v=190

(d) v=192

Solution: The correct answer is d.

(i) Returning to the situation initially described in the exercise (i.e. v = 0), what happens to the optimal choice

of the individual in terms of consumption, leisure and hours worked if the wage rate now rises to w = 8?

(a) L=8.5, C=60, H=15.5

(b) L=4.8, C=76.8, H=19.2

(c) L=12 C=48, H=12

(d) None of the above

Solution: The correct answer is b.

(j) How would you interpret the result on labour supply obtained in point (i) in terms of income and substitution

effects?

(a) The income effect leads to a reduction in labour supply, while the substitution effect has the opposite

effect. The income effect prevails

(b) The income effect leads to a reduction in labour supply, while the substitution effect has the opposite

effect. The substitution effect prevails

(c) The income effect leads to a reduction in labour supply, while there is no substitution effect

(d) The income and substitution effect perfectly compensate each other

Solution: The correct answer is b.

2. A labour market is composed of two types of workers: high and low skilled ones (denoted by H and L, respectively).

The productivity of high skilled workers is equal to 8 (ah = 8), while the productivity of low skilled workers is

equal to 4 (al = 4). The employer does not directly observe the productivity level of a worker, but knows the

overall distribution of workers’ types in the labour market. In particular, high skilled workers constitute 40% of
Labour Economics (BSc) Academic year 2019-2020

the total labour market while the remaining 60% is composed by low skilled workers. Finally, assume that all

workers can obtain utility u = 2 from an alternative activity. When indifferent between the wage offer and this

alternative, workers of all types accept the wage offer.

(a) Assume that the employer offers to all workers the same wage (w), corresponding to the average productivity

in the labour market. What would be the prevailing wage?

(a) w = 5.4

(b) w = 5.6

(c) w = 5.8

(d) w = 6

Solution: The correct answer is b.

(b) What is the level of expected profit (π) made by the employer under this wage offer?

(a) π = 0

(b) π = 1

(c) π = 2

(d) π = 3

Solution: The correct answer is a.

(c) The wage offer defined in (a) does not maximise expected profits for the employer. Maintaining the assump-

tion that the employer wants to offer a unique wage to all the workers (i.e. pooling equilibrium), what would

be the profit maximising wage offer?

(a) w = 0

(b) w = 1

(c) w = 2

(d) w = 3

Solution: The correct answer is c.

(d) What is the level of expected profits made by the employer under the wage offer obtained in (c)?

(a) π = 2

(b) π = 2.8

(c) π = 3.6

(d) π = 4.4
Labour Economics (BSc) Academic year 2019-2020

Solution: The correct answer is c.

(e) From now on, assume that workers can signal their skill type by acquiring education. However, obtaining
e∗8
a degree is costly and workers face the following utility function: U = w − λi , where e is equal to 1 if the

worker decides to acquire education and 0 otherwise. λi is a parameter that captures the inverse of the cost

of acquiring education for a specific productivity type, with λh = 4 for high skilled workers and λl = 2 for

low skilled ones. Assume that the employer offers a wage equal to 8 to workers with education and 7 to

workers without education. Which type of workers will acquire education under these conditions?

(a) Both high and low skilled workers will acquire education

(b) Neither high nor low skilled workers will acquire education

(c) High skilled workers will acquire education, but low skilled workers will not

(d) Low skilled workers will acquire education, but high skilled workers will not

Solution: The correct answer is b.

(f) Maintain the same conditions as above, but now assume that the employer offers a wage equal to 10 to

workers with education and 5 to workers without education. Which type of workers will acquire education

under these conditions?

(a) Both high and low skilled workers will acquire education

(b) Neither high nor low skilled workers will acquire education

(c) High skilled workers will acquire education, but low skilled workers will not

(d) Low skilled workers will acquire education, but high skilled workers will not

Solution: The correct answer is a.

(g) Finally, assume that the employer will offer a wage equal to 8 to workers with education and 5 to workers

without education. Which type of workers will acquire education under these conditions?

(a) Both high and low skilled workers will acquire education

(b) Neither high nor low skilled workers will acquire education

(c) High skilled workers will acquire education, but low skilled workers will not

(d) Low skilled workers will acquire education, but high skilled workers will not

Solution: The correct answer is c.

(h) Assume now that the employer wants to favour the emergence of a separating equilibrium, where high skilled

workers acquire education while low skilled workers do not. Also assume that, when indifferent between

acquiring and not acquiring education, workers of all types decide to acquire education. Which are the wage
Labour Economics (BSc) Academic year 2019-2020

offers for workers with and without education that maximise expected profits and that are compatible with

the emergence of such a separating equilibrium?

(a) wEducation = 6, wN oEducation = 2

(b) wEducation = 4, wN oEducation = 0

(c) wEducation = 6, wN oEducation = 3

(d) wEducation = 4, wN oEducation = 2

Solution: The correct answer is d.

(i) What is the level of expected profits made by the employer under the wage offer obtained in (h)?

(a) π = 2

(b) π = 2.8

(c) π = 3.6

(d) π = 4.4

Solution: The correct answer is b.

(j) Compare your answers to points (d) and (i) and derive which type of equilibrium will emerge in the labour

market

(a) A pooling equilibrium

(b) A separating equilibrium

(c) It depends on workers’ choice of education

(d) It cannot be inferred with the available information

Solution: The correct answer is a.

Labour Economics (BSc) Academic year 2019-2020

Labour Economics Final Exam

Please do not turn over your sheet until all students have

received their exam, and you have been instructed to start.

You have 2 hours to complete the exam.

Good luck!