PART II. Labor Supply and Demand Problems. Follow the instructions
for each item below carefully. 90 points total. This part of the exam is weighted
so that it is worth 40% of overall exam score.
The following passages are from Theodore Bergstrom and John Miller,
EXPERIMENTS WITH ECONOMIC PRINCIPLES, 1997, McGraw-Hill, pp. 167-175:
The February 4, 1995 edition of the NEW YORK TIMES reported that
President Clinton was seeking to increase the legal minimum wage from
$4.25 to $5.15 an hour.1 The President declared that “the only way to
grow the middle class and shrink the underclass is to make work pay.”
According to National Public Radio, Presidential Assistant Leon Panetta
asserted that an increase in the minimum wage would give people an
incentive to take jobs instead of collecting welfare benefits.
The Republican Speaker of the House, Newt Gringrich, reacted as
follows: “I am personally very skeptical of it, and I think it will kill jobs.”
According to the TIMES, the House Majority Leader, Dick Armey (who is
a former economics professor at the University of North Texas in
Denton) intended to fight the increase with “every fiber of his being.”
The president of the National Federation of Independent Business, a
small-business lobbying group, said that the proposal was “a regressive
and job-killing scheme which would put a big dent in small business
hiring.”
Which of these claims should we believe? In this part of the exam, you will
answer this question by completing the following:
1. Examine the tables below showing the demand and supply for labor in a
hypothetical job market. Then (neatly) draw supply and demand curves for
this labor market. You may use the back of this page to draw your graph.
Use a red pen or pencil to indicate the supply curve and a blue pen or pencil
to indicate the demand curve. Draw and label your axes using a black pen or
regular lead pencil. If you use pencils, make sure you draw your graph dark
enough so that I can read it. If you use pen, avoid “scratch outs.” These
make it VERY difficult to interpret your graph. In other words, exercise some
care in drawing your graph. (20 points)
Labor Supply
Wage Rate
Labor Supplied
Wage < $5
0
$5 < Wage < $12
15
Wage > $12
24
1
Legal minimum wage legislation does not apply to employees of firms in trade and
services with sales less than $250,000, to farm workers working on small farms, or to
domestic servants.
Labor Demand
Wage Rate
Wage > $25
$15 < Wage < $25
$5 < Wage < $15
Wage < $5
Labor Demanded
0
5
18
24
2. Now answer the following questions based on your graph. Answer these
questions on separate paper. Do not try to squeeze your answers in on this
page. [Assume that all of the premises of a perfectly competitive labor market
hold.]
a. If there is no minimum wage imposed on this labor market, what will the
equilibrium wage be? (5 points)
b. How many laborers or workers will be employed? (5 points)
c. How many laborers will be involuntarily unemployed? [To determine this,
recall our in-class discussion of the concept of a reservation wage. An
involuntarily unemployed worker is one who would take a job above
her/his reservation wage, if it were offered.] (5 points)
d. How many laborers would be voluntarily unemployed? [A voluntarily
unemployed worker is one to whom a job is offered but who will not take
the job because the wage offered is below her/his reservation wage.] (5
points)
e. Suppose a minimum wage of $10 is imposed on this labor market.
Reproduce your earlier graph describing the competitive market for labor.
Indicate on your new graph the $10 minimum wage as a horizontal line
coming out of the vertical axis. What effects, if any, would it have on
employment and/or total income of laborers? Be precise in your answer.
Explain why these affects would occur? (10 points)
f. Suppose a minimum wage of $16 is imposed on this labor market.
Reproduce your earlier graph describing the competitive market for labor.
Indicate on your new graph the $16 minimum wage as a horizontal line
coming out of the vertical axis. What effects, if any, would it have on
employment and/or total income of laborers? Be precise in your answer.
Explain why these affects would occur? (10 points)
g. Assume that the number of workers who find jobs when the $16 minimum
wage is enforced is equal to the number that firms are willing to hire at that
wage. How many jobs are eliminated by the minimum wage? (4 points)
h. With a minimum wage of $16, how many workers are involuntarily
unemployed? (3 points)
i.
With a minimum wage of $16, how many workers are voluntarily
unemployed? (3 points)
j.
Does the minimum wage increase or decrease the total profits of firms?
[Think carefully about how you would calculate this. Remember: Firms
are consumers of labor in this market.] (10 points)
k. Based on your analysis of this hypothetical market, whose predictions
would you say are more likely to be correct: President Clinton and Leon
Panetta or Newt Gringrich and the president of the NFIB. Explain your
answer fully in a paragraph. Consider the possibilities that both views are
correct, or that both views are incorrect. If you find either of these
possibilities to be true, reconcile the apparent contradiction in the political
rhetoric on each side. (15 points)