SFU Econ 113: Practice Final Joshua F. Boitnott, PhD Book Questions • Chapter 22: Questions for Review 1. What is moral hazard? List three things an employer might do to reduce the severity of this problem. 2. What is adverse selection? Give an example of a market in which adverse selection might be a problem. 3. Define signalling and screening, and give an example of each. • Chapter 22: Problems and Applications 2. Suppose that the Live-Long-and-Prosper Life Insurance Company charges $5000 annually for an insurance policy. The company’s president suggests that the company raise the annual price to $6000 in order to increase its profits. If the firm followed this suggestion, what economic problem might arise? Would the firm’s pool of customers tend to become more or less healthy on average? Would the company’s profits necessarily increase? 2. A case study in this chapter describes how a boyfriend can signal to a girlfriend that he loves her by giving an appropriate gift. Do you think saying “I love you” can also serve as a signal? Why or why not? 4. Some AIDS activists believe that life insurance companies should not be allowed to ask applicants if they are infected with HIV, the virus that causes AIDS. Would this rule help or hurt those who are HIV-positive? Would it help or hurt those who are not HIV-positive? Would it exacerbate or mitigate the problem of adverse selection in the market for life insurance? Do you think it would increase or decrease the number of people without life insurance? In your opinion, would this be a good policy? 5. The government is considering two ways to help the needy: giving them cash, or giving them free meals at soup kitchens. Give an argument for giving cash. Give an argument, based on asymmetric information, for why the soup kitchen may be better than the cash handout. • Chapter 18: Problems and Applications 2. Give two examples of events that could shift the demand for labour and explain why they do so. 3. Give two examples of events that could shift the supply of labour, and explain why they do so. 4. Explain how the wage can adjust to balance the supply and demand for labour while simultaneously equalling the value of the marginal product of labour. 5. If the population of Canada suddenly grew because of a large immigration, what would happen to wages? What would happen to the rents earned by the owners of land and capital? • Chapter 18: Problems and Applications 1. Suppose that the prime minister proposes a new law aimed at reducing heath care costs: All Canadians are to be required to eat one apple daily. (a) How would this apple-a-day law affect the demand and equilibrium price of apples? (b) How would the law affect the marginal product and the value of the marginal product of apple pickers? (c) How would the law affect the demand and equilibrium wage for apple pickers? 3. Your enterprising uncle opens a sandwich shop that employs 7 people. The employees are paid $15 per hour, and a sandwich sells for $3. If your uncle is maximizing his profit, what is the value of the marginal product of the last worker he hired? What is that worker’s marginal product? 4. Suppose a freeze in British Columbia destroys part of the apple crop. (a) Explain what happens to the price of apples and the marginal product of apple pickers as a result of the freeze. Can you say what happens to the demand for apple pickers? Why or why not? (b) Suppose the price of apples doubles and the marginal product falls by 30 percent. What happens to the equilibrium wage of apple pickers? (c) Suppose the price of apples rises by 30 percent and the marginal product falls by 50 percent. What happens to the equilibrium wage of apple pickers? 5. During the 1980s and 1990s Canada experienced a significant inflow of capital from other countries. (a) Using a diagram of the Canadian capital market, show the effect of this inflow on the rental price of capital in Canada and on the quantity of capital in use. (b) Using a diagram of the Canadian labour market, show the effect of the capital inflow on the average wage paid to Canadian workers. 7. This chapter has assumed that labour is supplied by individual workers acting competitively. In some markets, however, the supply of labour is determined by a union of workers. (a) Explain why the situation faced by a labour union may resemble the situation faced by a monopoly firm. (b) The goal of a monopoly firm is to maximize profits. Is there an analogous goal for labour unions? (c) Now extend the analogy between monopoly firms and unions. How do you suppose that the wage set by a union compares to the wage in a competitive market? How do you suppose employment differs in the two cases? (d) What other goals might unions have that make unions different from monopoly firms? • Chapter 19: Questions for Review 3. How might education raise a worker’s wage without raising the worker’s productivity? 4. What conditions lead to economic superstars? Would you expect to see superstars in dentistry? In economics? Explain. 5. Give three reasons why a workers wage might be above the level that balances supply and demand. 7. Do the forces of economic competition tend to exacerbate or ameliorate discrimination on the basis of race? 8. Give an example of how discrimination might persist in a competitive market. • Chapter 19: Problems and Applications 1. University and college students sometimes work as summer interns for private firms or the government. Many of these positions pay little or nothing. (a) What is the opportunity cost of taking such a job? (b) Explain why students are willing to take these jobs. (c) If you were to compare the earnings later in life of workers who had worked as interns and those who had taken summer jobs that paid more, what would you expect to find? 3. A basic finding of labour economics is that workers who have more experience in the labour force are paid more than workers who have less experience (holding constant the amount of formal education). Why might this be so? Some studies have also found that experience at the same job (called job tenure ) has an extra positive influence on wages. Explain why this might occur. 4. At some colleges and universities, economics professors receive higher salaries than professors in some other fields. (a) Why might this be true? (b) Some other colleges and universities have a policy of paying equal salaries to professors in all fields. At some of these schools, economics professors have lighter teaching loads than professors in some other fields. What role is played by the differences in teaching loads? 5. Sara works for Steve, whom she dislikes because of his snobbish attitude. Yet when she looks for other jobs, the best she can do is find a job paying $10,000 less than her current salary. Should she take the job? Analyze Sara’s situation from an economic point of view. 6. A current debate in education is whether teachers should be paid on a standard pay scale based solely upon their years of training and teaching experience, or whether part of their salary should be based upon their performance (called “merit pay”). (a) Why might merit pay be desirable? (b) Who might be opposed to a system of merit pay? (c) What is a potential challenge of merit pay? (d) A related issue: Why might a school district decide to pay teachers significantly more than the salaries offered by surrounding districts? 11. This chapter considers the economics of discrimination by employers, customers, and governments. Now consider discrimination by workers. Suppose that some brunette workers did not like working with blonde workers. Do you think this worker discrimination could explain lower wages for blonde workers? If such a wage differential existed, what would a profit-maximizing entrepreneur do? If there were many such entrepreneurs, what would happen over time? Multiple Choice Questions 1. What does the basic neoclassical theory of the labour market predict? a. b. c. d. Workers earn a wage equal to the value they contribute to the economy. Wages are determined entirely by market supply. Wages are determined entirely by market demand. Workers are compensated based on their contribution to the social value of society. 2. Workers at a bicycle assembly plant currently make minimum wage. If the provicial government increases minimum wage by $1.00 an hour, what will likely happen? a. The quantity of workers demanded at the bicycle assembly plant with increase b. Both the supply and demand curves will shift right. c. The quantity of workers willing to supply their labour at the bicycle assembly plant with increase d. The firm will increase the total output proportionally to the increase in the minimum wage. 3. The difference between moral hazard and adverse selection is a. b. c. d. moral hazard has to do with unobservable characteristics of individuals moral hazard has to do with unobservable actions of individuals adverse selection is when individuals change their behaviors because of a contract adverse selection is when you choose the wrong answer on a test 4. Leaving a handsome tip for the waiter in full view of your dinner date is a a. b. c. d. Screening mechanism Signaling mechanism Way to waste money An indication you have “skin in the game” 5. When asymmetric information affects a relationship between two parties, what is always the case? a. b. c. d. Neither party is well informed. One party is better informed than the other party. Both parties are equally well informed. The government is better informed than either of the two parties. 6. Which of the following represents how the value of the marginal product of labour calculated? a. b. c. d. by by by by multiplying multiplying multiplying multiplying the the the the price of output by the quantity of labour wage by the quantity of labour wage by the marginal product of labour price of output by the marginal product of labour 7. Why do major-league baseball players get paid more than minor-league players? a. b. c. d. Major-league players are better athletes. The higher wage reflects a compensating differential. Playing in the major leagues in less pleasant than playing in the minor leagues. The higher wage is often due to educational discrepancies. 8. Economists generally agree on which of the following statements? a. The human capital theory provides the best explanation of discriminatory practices. b. Differences in average wages do not by themselves provide conclusive evidence about the magnitude of discrimination effects in labour markets. c. Discrimination is exclusively an economic, rather than political, phenomenon. d. Much of the wage differential observed in the economy is due to discrimination. 9. A college degree makes a person more productive according to which theories of education? a. b. c. d. both the human-capital theory of education and the signalling theory of education the signalling theory of education, but not the human-capital theory of education the human-capital theory of education, but not the signalling theory of education neither the human-capital theory of education nor the signalling theory of education 10. Mike wants to buy an ancient painting from a curator. Mike values the original painting at $50,000, while he does not have any value for a fake one. However, he cannot differentiate between the original painting and a fake painting. How much should he pay for the painting if he thinks that there is a 70 percent chance that the painting he is buying is original? a. b. c. d. $15,000 $35,000 $50,000 $70,000 True/False Questions In this section, there are True and False statements. If a statement is True, then writing True gets full marks. If a statement is False, then explaining why the statement is False earns full marks. Just knowing a statement is false and not knowing why will earn half marks. If the TA can not tell if you wrote a T or F, they will assume you got it wrong. 1. All differences in wages that are not accounted for by differences in humancapital investment are likely to be a result of discrimination. 2. The value of the marginal product of labour can be calculated as the price of the final good minus the marginal product of labour. 3. If employers use a college degree as a signal of a worker’s productivity level, then the only costs we need to take into account are the monetary costs of college (e.g. tuition). 4. Labour unions will raise the quantity of labour demanded. 5. A competitive, profit-maximizing firm hires workers up to the point at which the wage equals the price of the final good. 6. An example of an information asymmetry is when a worker knows more about his work effort than his employer does. Short Answer Questions 1. There are several prominent websites where people are able to post reviews about professors. Other students sometimes gather information from these websites to decide which professors’ classes they want to take. Discuss how adverse selection may influence the reviews and whether these reviews will accurately predict how a student would feel about a particular professor. 2. According to Forbes (2018) as the housing market in the U.S. has started to recover, the “residential construction wages have picked up a lot more than construction starts.” (Note: construction starts is another way to describe new residential house builds, i.e. the quantity of new houses.) a. Using the neoclassical theory (i.e. derived demand), explain how construction starts and construction wages are related. Assume all markets discussed are perfectly competitive. Use a graph of both residential housing and residental construction labour to assist your explanation. b. Is the idea in the quote consistent with the neoclassical theory discussed in class? In other words, can the neoclassical theory explain why wages increased by a larger percentage than new construction starts? c. What other theories could be used to explain the larger increase in construction wages relative to construction starts? 3. Consider a game between two firms where each firm can play: s1 = Invest in Safety and s2 = Do not Invest in Safety. Invest in Safety Do not Invest Invest in Safety Do not Invest $280,$280 $132.5,$332.5 $332.5,$132.5 $210,$210 (a) What is the dominant strategy here? What game is this? (b) Suppose the government considers the safety protocols to be a public good. If the government imposes a penalty of $80 when a firm does not invest in safety, what is the new payoff matrix? What is the dominant strategy? 4. Suppose you hear the following claim: “Health insurance in Canada is provided as a form of Social Insurance.” Explain this statement. What sort of advantages does this system have over say a private market for insurance? What sort of disadvantages does this system have relative to private markets? Is the trade-off worth it? Explain your answer and support it with ideas/facts/concepts discussed in this course. (Note: no marks for your opinion on if it is “worth it” or not, just on your explanation/support.) 5. It is important to note that insurance is generally thought of as being used to hedge again unexpected outcomes (i.e. areas where there is uncertainty over what will happen even without the asymmetric information issue). Nobel Prize winning economist Jean Tirole in The Economic for the Common Good (pg. 413) writes: Genetic background is the typical example of a characteristic that is not subject to moral hazard: we do not choose it in any way, whereas we can, through our behavior, influence the probability of a car accident (by driving carefully) or the theft of our vehicle (by parking it in a garage or locking the doors). Without regulation, individuals whose genetic tests suggest that they will be healthy for the rest of their lives would be able to use these results to obtain cheap insurance. There’s nothing wrong with that, you’ll say ... except that there is no free lunch. The cost of insurance for those whose genetic makeup suggests, on the contrary, a long-term malady or fragile health will see their insurance premiums rise to extremely high levels: farewell to mutuality and risk sharing. Again, information destroys insurance. Explain why Tirole suggests this would be the end of insurance. Why might countries make laws to limit the sharing of the sort of genetic data Tirole is describing? 6. In 2004, The New York Times reported that India might be losing its outsourcing edge due to rising wages. The reporter noted that a recent report “projected that if India continued to produce college graduates at the current rate, demand would exceed supply by 20% in the main outsourcing markets by 2008.” (a) Using economics terminology, explain what is happening in the market for Indian workers in outsourcing jobs according to the report. In particular, is demand for Indian workers increasing or decreasing? Is the supply of Indian workers increasing or decreasing? Which is shifting faster? How do you know? (b) In 2017, The New York Times reported that in India “from 2016 to 2021, the offshore services (i.e. outsourcing) industry will have average yearly growth of 8 percent, the research firm IDC estimated. The rate in the previous five years was 15 percent.” Explain why this might be happening. Make sure to include derived demand in your explaination.
