ECON 102 Tutorial: Week 10
Ayesha Ali
www.lancaster.ac.uk/postgrad/alia10/econ102.html
a.ali11@lancaster.ac.uk
office hours: 8:00AM – 8:50AM tuesdays LUMS C85
Question 1
H2OClean Ltd supplies domestic kitchen water filters to the retail market and hires workers
to assemble the components. A water filter sells for £26, and H2OClean can buy the
components for each filter for £1. Kevin and Sharon are two workers for H2OClean Ltd.
Sharon can assemble 60 water filters per month, and Kevin can assemble 70. If the labour
market is perfectly competitive, how much will each be paid?
If the labor market is perfectly competitive, then each worker will receive a wage equal to
their value of marginal product (VMP).
So, to find the wage, we need to find the VMP for each worker.
From lecture, we know that VMP is the net price of each unit sold.
So, VMP = Marginal Product of labor (Market Price of the good – Cost to produce the good)
Sharon’s marginal product is 60 air filters per month – that is the Marginal Product of her
laobr, so her VMP = (60)(£26-£1)
VMP = £1,500/month, so her wage will be £1,500/month.
Kevin’s VMP is (70)(£26-£1) = £1,750/month. So his wage will be £1,750/month.
Question 2(a)
Stone Inc. owns a clothing factory, hiring workers in a competitive market to cut denim to
make jeans. The fabric costs £5 per pair. The company’s weekly output varies with labour
usage, as shown in the table below.
Number of workers
0
1
2
3
4
5
6
Jeans (pairs/week)
0
25
45
60
72
80
85
If the jeans sell for £35 a pair, and the competitive market wage is £250 per week, how many
workers should Stone hire? How many pairs of jeans will the company produce each week?
Question 2(a)
Stone Inc. owns a clothing factory, hiring workers in a competitive market to cut denim to
make jeans. The fabric costs £5 per pair. The company’s weekly output varies with labour
usage, as shown in the table below.
Number
of
workers
Jeans
(pairs/w
eek)
0
1
2
3
4
5
6
0
25
45
60
72
80
85
Marginal
product of
labour
(pairs per
worker)
VMP
(£/week)
If the jeans sell for £35 a pair, and the competitive market wage is £250 per week, how many
workers should Stone hire? How many pairs of jeans will the company produce each week?
To answer this, we want to find where is the VMP = the market wage.
So, we need to find VMP. To find VMP, we need to first find out what the Marginal Product of
labor is, so we’ll add a column for MP, and a column for VMP to our table above.
Question
2(a)
Stone Inc. owns a clothing factory, hiring workers in a competitive market to cut denim to
make jeans. The fabric costs £5 per pair. The company’s weekly output varies with labour
usage, as shown in the table below.
If the jeans sell for £35 a pair, and the competitive market wage is £250 per week, how many
workers should Stone hire? How many pairs of jeans will the company produce each week?
After deducting the £5 cost of
the fabric, the company
received £30 from the sale of
each pair of jeans.
We can calculate the marginal
product of labour and the value
of the marginal product of
labour are shown in the
following table:
Number
of
workers
Jeans
(pairs/we
ek)
0
0
1
25
2
45
Since the market wage is
£250/week, it is not worthwhile
to hire the fifth worker, whose
VMP is only £240/week. The
firm hires 4 workers and
produces 72 pairs of jeans per
week.
3
60
4
72
5
80
6
85
Marginal
product of
labour (pairs per
worker per
week)
VMP
(£/week)
= MP(P–C)
25
750
20
600
15
450
12
360
8
240
5
150
Question 2(b)
Suppose the Clothing Workers Union now sets a minimum acceptable wage of £230 per
week. All the workers Stone hires belong to the union. How does the minimum wage affect
Stone’s decision about how many workers to hire?
A minimum wage (£230) that is below the equilibrium wage (£250) will have no effect on
Number
Jeans
Marginal
VMP
Stone’s decision.
of
workers
(pairs/we
ek)
0
0
1
25
2
45
3
60
4
72
5
80
6
85
product of
labour (pairs per
worker per
week)
(£/week)
= MP(P–C)
25
750
20
600
15
450
12
360
8
240
5
150
Question
2(c)
If the minimum wage set by the union had been £400 per week, how would the minimum
wage affect Stone’s decision about how many workers to hire?
If the minimum wage is £400/week, the union wage is now higher than the equilibrium wage.
Stone will no longer hire the fourth worker.
Number
of
workers
Jeans
(pairs/we
ek)
0
0
1
25
2
45
3
60
4
72
5
80
6
85
Marginal
product of
labour (pairs per
worker per
week)
VMP
(£/week)
= MP(P–C)
25
750
20
600
15
450
12
360
8
240
5
150
Question
2(d)
If Stone again faces a market wage of £250 per week but the price of jeans rises to £45, how
many workers will the company now hire?
If the market price of jeans rises to £45 a pair, the final column of the table now looks like this:
If the equilibrium wage is
£250/week, Stone will now
hire a fifth worker.
Number
of
workers
Jeans
(pairs/we
ek)
0
0
1
25
2
45
3
60
4
72
5
80
6
85
Marginal
product of
labour (pairs per
worker per
week)
VMP
(£/week)
= MP(P–C)
25
1000
20
800
15
600
12
480
8
320
5
200
Question 3(a & b)
Jones, who is currently unemployed, is a participant in three means-tested welfare programmes:
food vouchers, rent vouchers and day care vouchers. Each programme grants him £150 per month
in vouchers, which can be used like cash to purchase the good or service they cover.
a) If benefits in each programme are reduced by 40 pence for each additional pound Jones earns in
the labour market, how will Jones’ economic position change if he accepts a job paying £120 per
week?
Jones’s benefits will go down by (0.40)(£120/week) = £48/week in each programme.
The total reduction of benefits is 3x£48 = £144/week.
Another way we can think about this is, that if the benefits go down by .40 per £1 earned in wages,
and if there are three programs, then actually, his total benefits are reduced by 3x(.40) per £1
earned, or they are reduced by £1.20 for each £1 he earns in wages.
So, as long as his earnings are less than his benefits if he had no job, he is better off not working.
b) In the light of your answer to part (a), explain why means testing for welfare recipients has
undesirable effects on work incentives.
When means-testing applied to multiple programmes results in effective marginal tax rates above
100 percent, as in this case, a person’s net income goes down as a result of earning money in the
labour market. This creates a powerful incentive not to work.
Question 4(a)
Sue is offered a job re-shelving books in the University library from 12:00 to 13:00 each Friday.
Her reservation wage for this task is £10 per hour.
If the library director offers Sue £100 per hour, how much economic surplus will she enjoy as
a result of accepting the job?
When the £100/hour is paid directly to Sue, she accepts the job and enjoys an economic
surplus of £100 - £10 = £90.
Question 4(b)
Sue is offered a job re-shelving books in the University library from 12:00 to 13:00 each Friday.
Her reservation wage for this task is £10 per hour.
Now suppose the library director announces that the earnings from the job will be divided
equally among the 400 students who live in Sue’s residence. Will Sue still accept?
If the £100 were divided equally among the 400 residents of Sur’s residence, however, each
resident’s share would be only 25 pence.
So, accepting the job would thus mean a negative surplus for Sue of £0.25 - £10 = -£9.75, so
she will not accept the job.
Question 4(c)
Sue is offered a job re-shelving books in the University library from 12:00 to 13:00 each Friday.
Her reservation wage for this task is £10 per hour.
Explain how your answers to parts (a) and (b) illustrate one of the incentive problems
inherent in income redistribution programmes.
The income sharing arrangement is income redistribution of the most extreme form. Such
measures reduce the amount of income available by reducing Sue’s incentive to accept
employment that would have generated an economic surplus.
Question 5
Using the concepts you’ve learned in Week 9 Lectures, can you explain why professional
golfers earn more from endorsements than professional snooker players?
Here is the suggested answer:
The higher endorsement wage suggests that the value marginal product of a professional
golfer is greater than that of a snooker player, i.e. the golfer is more valuable to the
advertising firm than the snooker player. This reflects the much larger market size and fan
base of golf (as measured by TV viewing figures): many more people play or, even more
importantly, watch golf than snooker. So professional golfers are more famous than
professional snooker players.
Question 6
Suppose the demand and supply curves for unskilled labour are as shown in the graph below.
By how much will the imposition of a minimum wage of £12 per hour reduce total economic
surplus? Calculate the amounts by which employer surplus and worker surplus change as a
result of the minimum wage.
W
S
20
Without a minimum wage, both employers
and workers would enjoy economic surplus
of £50,000 a day (= 0.5 x (£20 - £10) x
(10,000)).
12
Employer Surplus
10
8
Worker Surplus
D
0
8,000 10,000
20,000
L
Question 6
Suppose the demand and supply curves for unskilled labour are as shown in the graph below.
By how much will the imposition of a minimum wage of £12 per hour reduce total economic
surplus? Calculate the amounts by which employer surplus and worker surplus change as a
result of the minimum wage.
W
S
20
Without a minimum wage, both employers
and workers would enjoy economic surplus
of £50,000 a day (= 0.5 x (£20 - £10) x
(10,000)).
12
10
8
D
0
8,000 10,000
20,000
L
With a minimum wage set at £12/hour,
employer surplus is now 0.5 x (£20 - £12) x (8,000) = £32,000 a day,
while worker surplus is now 0.5 x (£12 + (£12 - £8)) x 8,000 = £64,000 a day.
The minimum wage thus reduces employer surplus by £18,000 a day, and increases worker
surplus by £14,000 a day.
The net reduction in surplus is the area of the shaded triangle, 0.5 x (£12 - £8) x 2,000=
£4,000 a day.
Question 6
Suppose the demand and supply curves for unskilled labour are as shown in the graph below.
By how much will the imposition of a minimum wage of £12 per hour reduce total economic
surplus? Calculate the amounts by which employer surplus and worker surplus change as a
result of the minimum wage.
Without a minimum wage, both employers
and workers would enjoy economic surplus
of £50,000 a day (= 0.5 x (£20 - £10) x
(10,000)).
Employer Surplus
Worker Surplus
With a minimum wage set at £12/hour,
employer surplus is now 0.5 x (£20 - £12) x (8,000) = £32,000 a day,
while worker surplus is now 0.5 x (£12 + (£12 - £8)) x 8,000 = £64,000 a day.
The minimum wage thus reduces employer surplus by £18,000 a day, and increases worker
surplus by £14,000 a day.
The net reduction in surplus is the area of the shaded triangle, 0.5 x (£12 - £8) x 2,000= £4,000
a day.
Next Class
 Week 11 Worksheet
 Exam Revision (exam in week 12)


There will be a sample test posted on Moodle.
The exam will cover:




Economics material from Week 6 onwards
Math material on derivatives (Week 5 onwards?)
Economics questions will be short answer, and there will be 7
math questions (4 marks each).
Economics questions will likely involve you having to create or
use diagrams, and payoff matrices and/or decision trees. You
might also need to be able to solve problems algebraically.
 Have a nice holiday!