Unit 1 (Labour supply and Demand)

Question 1

Labour force (LF)

Answer 1

LF = employed (E) + unemployed (U)

Question 2

Labor Force Participation Rate

Answer 2

LFPR = LF/P

• P = civilian adult population 16 years or older not in institutions

Question 3

Employment Population Ratio (also called Employment Rate )

Answer 3

EPR = E/P

Question 4

Unemployment Rate

Answer 4

UR = U/LF

Question 5

Budget constraint

Answer 5

C =W(t-L)+V
C =Wh+V
- Consumption equals labor earning (wages × hours of work) plus
nonlabor income (V)

Question 6

Optimal consumption

Answer 6

• (MRS) between
  consumption and leisure equals the wage

Question 7

The Effect of a Change in Nonlabor Income on Hours of Work

Answer 7

• An increase in nonlabor income leads to a parallel, upward shift in
  the budget line, moving the worker
• If leisure is a normal good, hours of work fall

Question 8

The Effect of a Change in Nonlabor Income on Hours of Work

Answer 8

An increase in nonlabor income leads to a parallel, upward shift in
the budget line
- If leisure is inferior, hours of work increase.

Question 9

More Work at a Higher Wage

Answer 9

• When the substitution effect dominates the income effect, the
  worker decreases hours of leisure in response to an increase in the
  wage.

Question 10

Reservation wage

Answer 10

The lowest wage rate that would make the
person indifferent between working and not working

Question 11

Reservation Wage rules

Answer 11

• Rule 1: If the market wage is less than the reservation wage,
  then the person will not work.
• Rule 2: The reservation wage increases as non-labor income
  increases.

Question 12

Labour supply Curve

Answer 12

• Relationship between hours worked and the wage rate.
• At wages above the reservation wage, the labor supply
  curve is positively sloped (the substitution effect dominates the
  income effect).
• If the income effect begins to dominate the substitution, hours
  of work decline as the wage rate increases (a negatively sloped
  labor supply curve).

Question 13

Labor Supply Elasticity

Answer 13

• The labor supply elasticity (σ) measures responsiveness in hours
  worked to changes in the wage rate.
• < 1 = inelastic
• > 1 = elastic

Question 14

σ

Answer 14

• Percent change in hours worked divided by the percent
  change in wage rate

Question 15

Policy Application: Welfare Programs and Work Incentives

Answer 15

• Cash grants reduce wage incentives.
• Welfare programs create work disincentives.
• Welfare reduces supply of labor by increasing non-labor income,
  which raises the reservation wage

Question 16

Policy Application: The Earned-Income Tax Credit (EITC)

Answer 16

• Tax credit of up to 40 percent of the earnings as long as the
  worker earns less than $14,040 per year;
• The EITC encourages some nonworkers to start working and
  never encourages a worker to quit working

Question 17

Labor Supply Over the Life Cycle

Answer 17

• Wages are low when young.
• Wages rise with time and peak around age 50.
• Wages decline or remain stable after age 50

Question 18

Added worker effect

Answer 18

• When non worker joins the workforce due to bread winners unemployment, to stabilise household income
• e.g. house wife picks up part time work
• added worker effect is countercyclical

Question 19

Discouraged worker effect

Answer 19

• Unemployed workers find it very difficult to find jobs during a
  recession, so they give up searching.
• Discouraged workers exit the labor force during bad times.
• The labor force participation rate of discouraged workers is pro-
  cyclical.

Question 20

Welfare programs

Answer 20

Welfare programs create work disincentives because they
provide cash grants to participants as well as tax those
recipients who enter the labor market. In contrast, credits on
earned income create work incentives and draw many
nonworkers into the labor force.

Question 21

Firm’s production function

Answer 21

q=f(E,K)

Question 22

profit function

Answer 22

• Profits = pq − wE − rK
• Total Revenue = pq
• Total Costs = (wE + rk)

Question 23

Value of Marginal Product of Employment

Answer 23

VMP(E) is the
marginal product of labor times the dollar value of the output

Question 24

Maximizing Profits

Answer 24

-Profit Maximization: A firm should produce until the cost of one more unit (marginal cost) equals the revenue from that unit (marginal revenue).
- Marginal Productivity Condition: Hire workers until the value of their output matches their wage.

Question 25

The cost of producing an extra unit of output

Answer 25

MC = w x (1/MPe) MC = Marginal cost w = wage MPe = marginal product of labour

Question 26

Critiques of Marginal Productivity Theory

Answer 26

- bears little relation to the way that employers make hiring decisions. - assumptions of the theory are not very realistic. - However, employers act as if they know the implications of marginal productivity theory

Question 27

Isoquant curves

Answer 27

-describe the possible combinations of labor and capital that produce the same level of output

Question 28

Isocost Lines

Answer 28

The isocost line indicates all labor–capital bundles that exhaust a specified budget for the firm

Question 29

Costs

Answer 29

C= wE +rK

Question 30

Slope of isocost

Answer 30

equals the ratio of input prices (−w/r)

Question 31

Firm cost minimisation

Answer 31

- firms costs are minimised where the isoquant is tangent to the isocost - MRS = w/r - MPE / MPK = w/r - MPE/w = MPK/r

Question 32

Long-Run Demand for Labor (wage drop)

Answer 32

- Scale effect - Substitution effect

Question 33

Scale effect

Answer 33

- The firm takes advantage of the lower price of labor by expanding production

Question 34

Substitution effect

Answer 34

- The firm takes advantage of the wage change by rearranging its mix of inputs, by employing more labor and less of other inputs, even if holding output constant

Question 35

Elasticity of Substitution

Answer 35

- percentage change in the capital-to-labor ratio given a percentage change in the price ratio - %∆(K/L) ÷ %∆(w/r)

Question 36

Marshall’s Rules

Answer 36

Labor Demand is more elastic when: - The elasticity of substitution is greater. - The elasticity of demand for the firm’s output is greater. - Labor’s share in total costs of production is greater. - The elasticity of supply of other factors of production such as capital is greater.

Question 37

Cross-elasticity of factor demand

Answer 37

- Percent change in Qx/ percent change in Py - Qx is the original quantity of factor x - Py is the original price of factor y - If cross-elasticity is positive, the two inputs are said to be substitutes in production

Question 38

The Demand Curve for a Factor of Production (input i) Affected by the Prices of Other Inputs

Answer 38

- price of substitutable input rises, the demand curve for input i shifts up - price of a complement rises, the demand curve for input i shifts down.

Question 39

The Employment Effects of Minimum Wages

Answer 39

- The unemployment rate is higher the higher the minimum wage the more elastic the labor supply and demand curves are. - The benefits of the minimum wage accrue mostly to workers who are not at the bottom of the distribution of permanent income

Question 40

Market types

Answer 40

- Monopsony: one buyer of labor - Monopoly: one seller of labor