Problem set 1

1. What happens to a worker’s desired hours of work if his/her wage rate increases?
Show on graph and discuss.

2. What happens to a worker’s desired hours of work if employers pay an overtime premium equal to 1.5
times the straight-time wage for any hours worked in excess of 40 hours? What would happen to hours of
work if the overtime premium were raised to double the straight-time wage?

3. Cindy gains utility from consumption C and leisure L. The most leisure she can consume in any given
week is 168 hours. Her utility function is U(C,L) = C × L. Cindy receives $630 each week from her great
grandmother– regardless of how much Cindy works. What is Cindy’s reservation wage?

4. Cindy gains utility from consumption C and leisure L. The most leisure she can consume in any given
week is 168 hours. Her utility function is U(C,L) = C × L. Cindy’s wage rate is $10/hour. She does not
have any non-labor income. What is Cindy’s optimal amount of consumption and leisure? What is
Cindy’s total utility at the optimal amount of C and L? What is her utility when she works 0 hours?

5. Cindy gains utility from consumption C and leisure L. The most leisure she can consume in any given
week is 168 hours. Her utility function is U(C,L) = C × L. Cindy’s wage rate is $10/hour. She does not
have any non-labor income. If the government starts a welfare policy that pays B to all non-workers and
pays $0 to all workers, at what value of B will Cindy opt out of the labor force in order to go on welfare?

6. Suppose the hourly wage is $10 and the price of each unit of capital is $25. The price of output is
constant at $50 per unit. The production function is
f(E,K) = E½K½,
If the current capital stock is fixed at 1,600 units, how much labor should the firm employ in the
short run? How much profit will the firm earn?

7. Suppose there are two inputs in the production function, labor and capital, and these two inputs are
perfect substitutes. The existing technology permits 1 machine to do the work of 3 persons. The firm
wants to produce 100 units of output. Suppose the price of capital is $750 per machine per week.
i) What combination of inputs will the firm use if the weekly salary of each worker is $300?
ii) What combination of inputs will the firm use if the weekly salary of each worker is $225?
iii) What is the elasticity of labor demand as the wage falls from $300 to $225?

8. A firm’s technology requires it to combine 5 person-hours of labor with 3 machine-hours to

produce 1 unit of output. The firm has 15 machines in place and the wage rate rises from $10 per hour to
$20 per hour. What is the firm’s short-run elasticity of labor demand?

9. (a) What happens to the long-run demand curve for labor if the demand for the firm’s output
increases?
(b) What happens to the long-run demand curve for labor if the price of capital increases?

10. In a particular industry, labor supply is ES = 10 + w while labor demand is ED = 40 − 4w, where
E is the level of employment and w is the hourly wage.
(a) What is the equilibrium wage and employment if the labor market is competitive? What is the
unemployment rate?
(b) Suppose the government sets a minimum hourly wage of $8. How many workers would lose their
jobs? How many additional workers would want a job at the minimum wage? What is the unemployment
rate?