ECON 327 – Labor Economics
Spring 2015
Name_______________________________________
Problem Set #1
Due Wednesday, January 21 – Turn in as hardcopy or electronically as PDF or Word Document.
1.
(5) What do economists mean by the term “rational behavior”? Most economic models specify the goal
of behavior as utility, profit, or income-maximization. But Adam Smith argued that “Man naturally
desires, not only to be loved but to be lovely.” By “lovely” Smith meant respected, honored, admired,
and praised. Is it possible to model this desire – to be loved and to be lovely – as rational behavior? Why
or why not?
2.
(5) The demand for labor is a derived demand. What does this mean?
3.
(10) Let L denote the level of employment and W the hourly wage in each of the following markets. For
each of the following changes, indicate the direction of expected change in W and L and give a brief
argument why. Each change is a ceteris paribus change.
(a) Suppose that consumers place greater value on early childhood education. What happens to W and L
in the market for pre-school teachers?
(b) Suppose that the government raises pay for economists it employs in regulatory agencies. What
happens to W and L in the market for academic economists?
(c) Suppose that widgets are made by a combination of high-skilled labor, low-skilled labor, and
machinery. What happens to W and L for high-skilled and low-skilled labor if new machinery is
introduced that is more computerized and technically sophisticated?
(d) Suppose that legislators abolish the penalty for soliciting the services of sex-workers (aka
prostitutes). What happens to W and L for sex-workers?
4.
(10) (a) Define absolute advantage and comparative advantage.
Suppose that A can earn $30 per hour in the market or produce $10 worth of home production per
hour, while B can earn $10 per hour in the market or produce $5 worth of home production per hour.
Suppose each person has 12 hours per day to allocate to market or home production.
(b) Identify who has the absolute advantage and comparative advantage in market and home
production.
(c) Graph the individual income possibility frontiers for A and B. (You should have two graphs)
(d) Initially, suppose that A and B make their decisions independently and each works 8 hours in the
market and 4 hours in home production. Show these decisions in the graph above, marking A’s decision
A* and B’s decision B*.
(e) What is the total monetary value of A’s choice? What is the total monetary value of B’s choice? Who
is richer?
(f) Graph the social income possibility frontier for A and B combined. Show the joint independentdecision solution as C* (C* is the “sum” of A* and B*). What is the total monetary value of C*?
(g) What happens to the total monetary value of production if A works one more hour in home
production and B works one less hour in the market? What happens to the total monetary value of
production if A works one more hour in the market and B works one less hour in home production?
Where will the joint monetary value of home and market production be maximized (Who works how
many hours in each alternative)?