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Labor Economics
Exercises 1. Labor Supply Question 1. Suppose that the
Government is considering implementing the following support
program: if the individual is unemployed receives an income subsidy
in the amount of X Euros, however, if the individual starts working
loses the right to receive this subsidy. Show, with a graphical
representation, that this policy can lead the individual to stop
working. Suggestion: For simplicity, assume that the individual
does not receive non-wage income. Question 2. If Joana works up to
40 hours per week, she earns a wage of 15 per hour. Beyond the 40h,
for each overtime hours she receives 30/h. We also know that Joan
has to pay a wage income tax rate of 20%. When Joana is working,
she has to leave their children to the care of a babysitter, who
she pays 4 per hour. Additionally, Joana receives a weekly subsidy
of 80 from the Government. Knowing that Joana has 168 hours
available to allocate between work and leisure, represent
graphically Joanas budget constraint. Question 3. John has the
following utility function:
U(C,L) = ( C 200 ) ( L 80 ) We know that John has 168 hours per
week available to allocate between work (h) and leisure (L) and
that he earns a net wage of 5 per hour. Admit that, each week, he
earns non-wage income of 320 . .
a) Derive and represent graphically Johns budget constraint.
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b) What is the marginal rate of substitution (MRS) when L=100
and is on the budget constraint?
c) Define reservation wage. What is the reservation wage for
John? d) What is the optimal choice of consumption (C) and leisure
(L)?
Question 4. Miguel's preferences are given by:
U(C,L) = C L
Consider that Miguel has 168 hours available per week and that
he earns 10 per hour. a) What is the optimal choice of consumption
(C) and leisure (L)? b) If the government implements a policy where
it pays X euros to all unemployed
individuals and 0 for all the employed, which is the value of X
that will impel Miguel to leave the labor market?
Question 5. The government of country X is concerned with the
access of the poor individuals to legal services. Thus, the
government implemented a policy which requires that lawyers devote
5% of their work time to provide free services to the poor
individuals.
a) (3 points) Represent graphically the impact of this policy on
Johns temporal budget constraint, who is a lawyer. Justify. Hint:
Assume that Johns non-wage income (V) is zero.
b) (5 points) The Lawyers Association issued a statement arguing
that this policy provides a clear disincentive to work. Do you
agree that this measure always leads to a decrease in the number of
hours of work? Illustrate with a graph. Decompose and explain the
substitution effect and the income effect.
Question 6. 50% cut in overtime payments until 2013 The
Government wants to cut in half, by the end of 2013, the value of
the wages paid to public employees for overtime, according to the
preliminary version of the law proposal, which Lusa had access. The
document aims to change the values of hourly remuneration regarding
the payment of overtime provided on normal working day as long as
we are under the Program of Economic and Financial Assistance to
Portugal , i.e., until the end of 2013.
Source: www.jn.pt; 12/10/2011 - 23:19
a) Discuss, carefully explaining the concepts used, what could
be the impact of this law proposal in the labor supply of a worker
who works overtime. [maximum 10 lines]
b) Discuss, carefully explain the concepts used, what will be
the impact on the demand for capital in the long-run assuming a
technology in which inputs are perfect complements. [maximum 10
lines]
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Question 7. PSD (Social Democratic Party) wants unemployed
individuals to do unpaid work three days a week If the proposal of
PSD to make mandatory the provision of a solidarity tax is
approved, the unemployed individuals receiving unemployment benefit
will be required to provide service to the community in a public
institutions or in an institution of the social sector for 15 hours
per week,
Source: www.jornaldenegocios.pt; 17/05/2010 Carefully explaining
all the concepts used, represent and compare, on the same graph,
the situation of an individual receiving unemployment benefit who
is not required to provide community work and an individual to whom
this solidarity tax is required. Question 8. Joana's preferences
for consumption (C) and leisure (L) are given by:
U(C,L) = C L
Joana has 168 hours available per week and does not have any
non-wage incomes. Currently, the optimal choice of Joana is to
enjoy 84 hours of leisure and spend 840 on consumption. If the
government implements a policy that pays X euros to all unemployed
individuals and 0 to all employees, which is the value of X that
will drive Joana to stop working? Justify using a graph. Question
9. Joss preferences for consumption (C) and leisure (L) are given
by:
0,2 0,8U(C,L) = C L
It is known that Jos has 168 hours per week available to
allocate between work (h) and leisure (L) and earns a net wage of 4
per hour. Also assume that Jos doesnt have any other non-wage
incomes.
a) Derive and represent graphically Joss budget and time
constraint. b) What is the optimal choice of consumption and
leisure? How many hours will
Jos work per week? What is his monthly income? c) Read carefully
the following text:
[The beneficiaries] lose the right to the unemployment benefit
if, unjustifiably: refuse a suitable employment or the Personal
Employment Plan (...) Do not present to an entity to which they
have been referred to by the Job center (eg., for an interview).
Fail more than twice the duty to: - Actively seek for employment,
(...)
Source: Guia Prtico Subsdio de Desemprego, Instituto da Segurana
Social, Fevereiro de 2009
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Discuss the reasons which lead the policymaker to include these
restrictions in the unemployment subsidy. In this context, suggest
a maximum monthly value for the unemployment benefit paid to
Joseph
Question 10.
Portugal, Spain and Greece will have to reduce wages
Portugal, Spain and Greece, countries facing difficulties in
their public accounts, will have to take sacrifices, such as
reducing wages to increase competitiveness (...). This is the
reading of the economic environment that is going through some
European countries and, according to the chief economist of the
International Monetary Fund (IMF), Olivier Blanchard, can lead to
'great sacrifices'.
Source: www.agenciafinanceira.iol.pt; 2010-02-02; 11:18
a) Suppose that real wages decrease in Portugal. In a
broadcasted debate about the labor market, one commentator makes
the following statement: The statistics may be incorrect because
the real wage is decreasing and the number of hours worked is
increasing. Discuss the statement of the commentator, applying the
appropriate economic concepts.
b) Explain and represent graphically the optimal decision of the
worker before and after the reduction of the real wage assuming
that, at the new equilibrium, the number of worked-hours increases.
Assume further that the employee does not receive other non-wage
incomes.
Question 11. Comment carefully the following statements using a
graph, when necessary:
a) The recent increase in the IRS (Portuguese tax on wage
incomes) will decrease the individuals incentive to work.
b) A decrease in non-wage incomes will reduce the individuals
incentive to work. 2. Labor Demand Question 1. Firm ABC produces
its product in a perfectly competitive market, using as inputs L
(labor) and K (capital) and with the following production
function:
Q(L,K) = 6KL2-L3
In the input markets there is also perfect competition.
Additionally, it is known that in the short-run the fixed input (K)
is equal to 2 units.
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It is assumed that the equilibrium price of the final product is
10 m.u. and the price of the variable factor (L) is 50 u.m.
a) Determine the analytical expressions of the Value of the
Marginal Product and the Value of the Average Product of the
variable factor. Represent graphically and explain the economic
meaning of these two concepts.
b) Determine the number of employees that the firm will hire in
the labor market if it wants to maximize the profit.
c) As you know, the entrepreneur can always choose not to
produce. What is the wage rate that drives the firm not to
produce
d) What is the firms short-run demand curve. Represent
graphically. Question 2. Assume that the long-run production
function of a firm is given by:
Q= 3K1/3L1/3
Both the product and the inputs markets are perfectly
competitive, with r = 1, w = 0.5 and P = 1.
a) Determine the combination of inputs K and L that maximize the
firms profit and the associated level of output. Represent
graphically.
b) Suppose that the wage increased to 1. Determine the new
combination of inputs that maximizes profit and new level of
output. Represent graphically.
c) Represent graphically the substitution effect and the scale
effect. Give the economic intuition behind these effects. Classify
the inputs.
d) What is the impact on the demand curve for capital caused by
this increase in the wage?
Question 3. Suppose that there is perfect competition in the
market for the production of carpets. Firm Alfa is the only firm
that is installed in a county within the country where the
workforce has no other source of wage income. The production
technology of carpets is given by:
Q(L,K) = 24,4LK-4L2 The labor supply is the following:
W(L) = 240+6L The price of each meter of carpet is 1 m.u. and
the price of the input capital is 1110 m.u. It is known that the
firm Alfa uses, at the moment, 100 units of capital and 120
employees. Assuming that the firm operates in the short-run, where
the capital is fixed capital, answer the following questions:
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a) What is the profit that the firm earns now? b) Is the firm
maximizing its profit? If not, what is the maximum profit that
the
firm could get? c) Without doing calculations, on the same
graph, identify the perfect competition
equilibrium in the inputs market. Comment. Question 4. ABC is
the only producer of an innovative product and has to meet the
global demand for the product that has the following
expression:
Px = 400 - X/8
The production process is characterized by the following
production function:
X = 2KL
Given the complexity that surrounds the production process, the
labor is highly specialized and offered according to the following
function:
W = 200+2L
It is known that the firm is using 4 machines (K) acquired at
unitary price of 50 000 m.u. What is the optimal amount of labor
that the firm must hire and which is the maximum profit that the
firm can get? Question 5. ABC is a firm that produces computer
components, presenting the following production function: Y = KL -
L2 The firms total revenue is given by: TRY = 100Y It is known that
the labor supply is given by W(L) = 500 + L and that the firm
currently uses 50 units of the input capital acquired at the price
of a 500 m.u.
a) Present and interpret the condition that will allow firm ABC
to determine the number of workers that maximizes its profit.
b) How many workers should the firm hire? What is the wage? What
is the quantity of output produced? What is the firms profit?
Justify and represent graphically your answer.
c) An employee of the firm suggests that there was a mistake in
the estimation of the production function and that the real firms
technology is given by: Y = K + L. Therefore, this employee says
that in the long-run, the firm must make radical
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adjustments in the used quantity of inputs K and L. Do you agree
with this employee? Justify.
Question 6. The FCP Ltd firm produces soccer balls and has the
following production function:
Q(K,L)= 200KL-2L2 In the short run, the amount of capital (K) is
fixed at 10 units. The price (P) of each soccer ball is 2 euros and
the wage is given by:
W(L)= 200+2L. Determine and compare the equilibriums in
monopsony and perfect competition. Plot (in the same graph) and
explain carefully the differences between the two equilibriums.
Question 7. A million robots to replace workers at Foxconn The
group Foxconn Technology, during the next three years, will replace
workers by one million robots. The firm from Taiwan, responsible
for assembling the IPhone and IPad, justifies that this change is
due to the rising costs of labor.. The firm, which has been
questioned about their working conditions, is planning to use
robots for simple tasks in the assembly line, such as spraying and
welding, carried out mainly by workers, said the president of the
Foxconn, Terry Gou.
Source: www.jn.pt; 02/06/2011 Which type of workers is the most
affected by this measure and why? Explain carefully the effects and
represent graphically. Question 8. Suppose a technology in which
there are only two factors of production, capital (K) and labor (L)
that are perfect complements. Assuming an increase in the price of
labor explain and decompose the substitution effect and the scale
effect. Question 9.
The firm APOLLO, Ltd. is the only producer of an innovative
system that uses solar energy. The manufacturing process uses two
inputs, labor (L) and capital (K) and can be represented by the
following production function:
X = KL
The demand for the product is given by: P(X) = 200 - X
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Since this is an extremely innovative technology the labor work
used in the production process requires very specific training and
is highly specialized. The labor supply function is given by:
W(L) = 100 + L
It is known that, currently, the firm is using 2 units of
capital (K) acquired at the price of 300 m.u.
a) Identify the market structure that the firm faces in the
product market and in the input markets. Justify.
b) What is the optimal number of employees (L) that the firm
must hire in order to maximize its profit. Justify carefully.
c) What is the maximum profit that the firm will get? Justify.
Question 10. Cassava starch is used in the chemical, food,
metallurgical, textile and pharmaceutical, industries. Suppose that
the market for cassava starch is perfectly competitive. The company
Cassava Ltd, dedicated to this production, is the only firm
installed in rural Malawi, where the working population has no
other source of wage income. The production technology of cassava
starch uses three inputs cassava (M), work (L) and capital (K) and
can be represented by:
Q(M,K,L) = MKL-L2
The supply of labor in the region is given by:
W(L) = 500+2,5L It is known that the price of cassava starch is
10 euros a tonne. The firm currently has the input capital fixed in
one unit and, in short-run the contractual conditions determine
that the acquisition of cassava is stable in a hundred tons per
month. Answer the following questions:
a) How many workers will the firm Cassava Ltd hire? What is the
workers monthly wage? Justify and represent graphically.
b) Suppose now that the firm is the only producer of cassava
starch. Based on a graph tell what would happen to the number of
workers hired by the firm and to the wage.
Question 11. In 1992, the minimum wage in New Jersey increased
from $4.25 to $5.05 per hour () Using information gathered by the
employers, Card and Krueger (1994) concluded that an increase in
the minimum wage increased employment in New Jersey
restaurants.
Source: http://en.wikipedia.org/wiki/Minimum_wage
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One of the hypotheses in the study is the existence of a
monopsonist market. Explain this hypothesis using a graph. Justify
adequately.
Question 12. With the decreasing price of new technologies, many
analysts projected that firms would fire workers replacing them
with more capital intensive technology. However, it is observed
that employment increased instead of decreasing. Explain what is
happening in this market. Justify. Question 13. Discuss the
following statement, adequately justifying your answer: After the
implementation of a minimum wage that has led to an increase in the
market wage, it was observed a decrease in the number of workers
hired. This allows us to conclude that the labor market is
perfectly competitive.
Monitoring costs Question 1. The finantial group FIN, SA is the
holder of two banks: the INVEST and the MONEY that are involved in
different activities. The MONEY - Commercial Bank is dedicated to
raising funds (deposits, mutual funds,...), the transfer of funds
(bank loans) and other services (bank guarantees, currency sales,
periodic payments,...). The INVEST - Investment Bank is dedicated
exclusively to activities related to capital market. The specifics
related to capital market lead the productivity of individuals in
the bank INVEST to be much more variable than in the bank MONEY.
Compiling data collected by the Human Resources Department over the
years, it was possible to classify individuals into five levels of
productivity:
A Very Bad B Bad C Medium D Good E Very Good
With the information collected, there were some difficulties in
quantifying the output of the individuals whose productivity was
classified as Very Bad. Tables 1 and 2 present the data on wages,
the proportion of individuals of each type and their average annual
output (thousand euros) to the banks INVEST and MONEY,
respectively.
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Table 1 Type of workers in bank INVEST Type A B C D E Proportion
of individuals 0,1 0,2 0,3 0,3 0,1 Average annual output ? 0 50 100
200 Average Wage 40000/year Table 2 Type of workers in bank MONEY
Type A B C D E Proportion of individuals 0,1 0,2 0,3 0,3 0,1
Average annual output ? 50 60 70 90 Average Wage 40000/year It is
also known that the average net revenue generated by a worker at
the bank INVEST is 15000/year and in the bank MONEY is 21500/year.
The Management of the group is considering the introduction of a
set of systems to control and monitor the productivity of workers
that would help to identify and fire individuals who are generating
a loss in each of the banks. A preliminary study commissioned by
the Administration indicates that the costs of implementing this
monitoring system would amount to 1,000 per worker. Considering the
above information, answer the following questions:
a) Suppose that you work in the Human Resources Department of
group FIN, SA and that you are responsible to complete the missing
information in Tables 1 and 2. What values would you suggest?
Justify your answer.
b) The Administration asked your department for a reasoned
opinion on the implementation of the monitoring system. What would
you respond to the Administration?
c) The Administration has little confidence in the study on the
costs of the monitoring system, believing that this costs can be
more or less than the amount indicated. So, you were asked, for
each bank, to determine the maximum value of monitoring costs that
make the implementation of the monitoring system advantageous.
Justify.
Question 2. Assume that in the firm ABC there are two types of
workers (type X and type Y) that differ in their productivity. The
firm has currently 600 employees and is considering implementing a
monitoring system to identify and fire workers that cause a loss to
the firm. It is estimated that the monitoring costs are 5 thousand
euros per year per worker. It is known that the average
productivity of workers of type X is 50 thousand euros per year and
that the productivity of workers of type Y is 20 thousand euros per
year. The annual average wage paid by the firm is 30 thousand
euros. How many employees and of which type should work at the firm
in order to make the implementation of the monitoring system
worthwhile?
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Question 3. Consider the following article: Microsoft creates a
software to monitor employees The American company plans to develop
a computer system that, thanks to wireless sensors, measure, all
the time, the heart rate, body temperature, movement, facial
expression and blood pressure of the worker. This type of
technology, which allows the observation of workers, was until now
limited to pilots and NASA astronauts (...)
Source: http://www.cedosoft.com, January 17, 2008 Comment this
excerpt explaining the circumstances in which it may be more
advantageous to implement a monitoring system of workers.
Choice between number of workers and the number of hours
worked
Question 1. How will the bank of hours work In practice, the
bank of hours allows firms to adjust their production schedules to
production peaks asking their employees to do more hours in a given
period. (...) This system can be used in periods of low business
activity, reducing the normal working day, but without the
reduction of wages. What remains is a credit of hours that can be
used when production increases or the economic activity grows.
Thus, if the bank of hours is applied at a time of great activity
of the firm, the work schedule can increases a maximum of two hours
a day.
Source: www.dinheirovivo.pt; 17/01/2012 Discuss the importance
of quasi-fixed labor costs when firms opt for the bank hours.
Question 2. For the following questions choose the best answer:
1. Legislation requiring employer-provided health insurance for
part-time workers would probably _________ the employment of
part-time workers and ________ the overtime of full-time
workers.
(a) increase; increase (b) increase; decrease (c) decrease;
increase (d) decrease; decrease
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2. A mandated increase in overtime pay is likely to
(a) raise the average costs of labor, even if all overtime hours
were eliminated. (b) cause an increase in labor hours due to the
scale effect. (c) cause employers to increase straight-time hourly
wages to compensate
(because of the package agreed upon). (d) cause an increase in
labor hours due to the substitution effect.
3. A mandated increase in overtime pay is likely to (a) cause
employers to reduce overtime hours and convert them into added
employment. (b) directly reduce the quasi-fixed costs per
worker. (c) lead to a reduction in employment if higher costs cause
a large scale effect. (d) lead to a reduction in employment if
those who work overtime and those who
are unemployed are perfect substitutes.
4. An increase in quasi-fixed costs would probably lead to a(n)
________ in the number of employees hired and a(n) _________ in the
number of overtime hours worked.
(a) increase; decrease (b) increase; increase (c) decrease;
decrease (d) decrease; increase
5. Which of the following is definitely NOT a quasi-fixed cost
of labor?
(a) unemployment insurance (b) health insurance (c) overtime pay
(d) vacation pay
6. A quasi-fixed cost of labor is a cost that
(a) is expected to change over time. (b) is proportional to the
number of hours worked. (c) is proportional to the number of
workers hired. (d) is proportional to the amount of capital
used.
7. Which of the following event will likely lead a firm to use
overtime rather than hire new workers:
(a) the firm gets rid of its pension plan. (b) the firm starts
to pay for health insurance. (c) the marginal productivity of all
workers, new and current, increases 20%. (d) both overtime and base
pay increase 20%.
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3. Education and Training Question 1. Consider the following
excerpt from an article published online in Jornal de Notcias: The
law that locks the exit of plane pilots is insufficient The
Republics President admitted yesterday, not to be "sufficient" the
law that locks the exit of plane pilots from the Portuguese Air
Force (FAP), most of which choose to transfer to civilian airlines.
Cavaco Silva confronted by military leaders with the problem of
scarcity of pilots, during a visit to Monte Real Air Base, recalled
having enacted a law amending eight to twelve years the permanence
of pilots in FAP. With this legislation a pilot who wants to leave
early will have to compensate the State. [...] Alexandra Serdio
Jornal de Notcias online, 18th October, 2007 Discuss the issues
raised in the article and do not forget to identify the economic
problem(s) underlying and the possible solutions. Question 2. The
company TEK, Inc. knows that, in the market, there are
approximately in the same proportion, two types of individuals that
differ in their intelligence, ability and innate skills: -
Individuals of type B (Bad): little diligent individuals with lower
skills and low productivity; - Individuals of type G (Good):
individuals very committed, capable and with high productivity. The
following table shows the present value of wages (i.e., the
discounted value of wages throughout the entire working life) that
the firm will be willing to pay for each type of individuals:
Type of worker Wage (actual value) Tipo B 200.000 Tipo G
300.000
Since the firm cannot observe the worker type, it requires a
signal for distinguishing them. The firm believes that having
higher education may signal and distinguish individuals. Thus, the
firm will adopt the following hiring policy: - To the individuals
with less than x years of higher education, the firm only pays
200,000 since it assumes that they are of type B;
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- To the individuals with at least x years of higher education,
the firm pays 300,000 because it believes that they are of type G.
Costs incurred during attendance of higher education are different
for each type of individual. An individual of type G has total
costs (including psychological costs, opportunity costs, etc..)
with higher education of 20,000 per year. The individuals of type
B, facing greater difficulties in learning, support a total annual
cost of 25,001. Based on the information presented above answer the
following questions (for simplicity, assume that the discount rate
is equal to 0):
a) In the absence of signaling, is there an adverse selection
problem? Justify your answer by explaining what is adverse
selection and to what extent it can be seen (or not) in this
market.
b) A manager of TEK, Inc. suggested that the problem of
identifying the workers would be easily solved if, during the
recruitment interview, the individual is asked to which group it
belongs. Discuss the suggestion of the manager.
c) Suppose that obtaining higher education does not bring any
costs for both types of individuals. What would happen?
d) According to the "theory of education as a signal" to what
extent higher education affects the productivity of individuals?
Justify and compare with "theory of investment in human
capital."
e) Determine the minimum number of years of education (x) that
the firm should require in order for workers of type B do not wish
to acquire the signal. Justify your answer graphically.
f) Determine the maximum number of years of education (x) that
the firm may require in order for the type G workers still wish to
acquire this signal. Justify your answer graphically.
g) Considering your answers to the previous questions and
assuming that markets are perfectly competitive, which is the
number of years of education (x) that the firm will require in its
recruitment policy? Justify.
Question 3. Consider the following excerpt from an article
published in a higher education magazine on RVAE - Recognition and
Validation of Learning Acquired by Experience () The RVAE is also a
symptom of the symbolic importance that academic certificates have
in society, implying the social recognition of the wisdom of
experience. This recognition weighs in the motivation of those who
intend to start a RVAE process but has also created in some schools
(...), the fear that the process involves the general devaluation
of academic certificates (...) Source: Slvia Ferreira; Ensino
Superior N. 14 Revista do Sindicato Nacional do Ensino Superior:
Dezembro 2004 - Janeiro 2005 Based on the materials covered in
class, discuss the issues raised in the article and do not forget
to explain the theory behind it.
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Question 4.
Suppose there are two types of workers: workers of type B (Bad)
and workers of type G (Good). It is known that the acquisition of
higher education will cost 20000 to individuals of type B but only
8000 to individuals of type G. The firms intend to use higher
education as a mechanism for selecting candidates. The firm plans
to pay 25000 to the workers without higher education and X to
graduated workers. What values should X assume so that higher
education could be properly used as signal? Justify. Question 5.
When Ken Hassey was hired by the Oakland Police Department, he
signed a conditional offer that required Hassey to repay $8,000.00
in training costs if he failed to work for the Police Department
for 5 years.
Source: http://blog.griegolaw.com (01/07/2008)
Based on the material covered during classes discuss the issues
raised in the excerpt. Question 6. Restrictions on training (...)
The underlying problem is that any firm that pays the training has
the risk of seeing their skilled workers being caught by its
competitors. (...)
Source: www.economist.com; 26/05/2011 Comment the excerpt
according to the theory on who should pay the training costs.
Question 7. Usually the employment contract establishes a
Permanency Pact in which the employee agrees not to cancel the
contract for a certain period. Explain the context in which this
type of arrangement makes sense. Question 8. Analyze the likely
impact of the following events on workers decision to invest in
human capita, ceteris paribusl:
a) Increase their discount rate. b) Increase the retirement age
from 65 to 70 years.
Question 9. Discuss the following statement, explaining
properly: In the model of specific training we observed that the
employee goes through a period of underpayment followed by a period
of overpayment."
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Question 10. Consider the following excerpt: Professional car
drivers require amendment of the law which requires the
Certificate
of Professional Aptitude Close to a hundred professional drivers
manifested today against the Department of Transportation requiring
modification of the law that requires workers to have the
Certificate of Professional Aptitude (CAM) in September (...) But
to have these documents we are required to have 35 hours of
training (...) [said the leader of the Federation of Trade Unions
of Transport and Communications (FECTRANS)] (...) At the origin of
the workers discontent is the law of 27 May, according to which the
charges related to the acquisition of the initial qualification and
periodic training should be the paid by the professional
drivers
Source: Jornal Sol online (8 de Julho de 2009) Discuss the
issues raised in the extract regarding to whom should pay for the
costs of training. Question 11. Considering the concepts presented
in classes, discuss following figure, justifying your answer.
Source: www.CartoonStock.com
Question 12. John and Louis are considering taking training in
order to improve their knowledge about the firms inventory
management. Assuming that this is a specific training and
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that John and Louis are identical in everything else except that
John is older, married and with children:
a) Explain what is specific training; b) Discuss who should pay
for training. Justify all your answers.
Question 13. Classify the following statements as true or false,
always briefly justifying your answer: The empirical finding that
women are less promoted than men implies that there is
discrimination. 4. Wages, incentive systems and motivation:
compensating differientials; variable pay; promotions; seniority;
efficiency wages and teamwork
Compensating Wage Differentials Question 1. On the labor market
for the perfume industry there are two types of workers, some who
do not like the smell of perfume that is felt in factories and
others who like the smell of perfume as long as this is not too
intense and exaggerated. It is known that there is no cost
associated with reducing the smell of perfume in the factories.
a) Represent graphically the indifference curves of the two
types of workers. Explain the shape of the curves.
b) Represent graphically the iso-profit curves. Explain their
format and identify the relevant iso-profit.
c) Explain and represent graphically the market equilibrium,
identifying the compensating wage differential.
Question 2. The increase in salary earned by individuals with
higher level of education can be seen as a compensating wage
differential. Individuals will only be willing to invest in
education if they have the expectation of receiving higher wages.
Thus, they have to consider the choice between a job that pays a
lower wage but requiring less education or a job that pays a higher
wage but also requires a higher level of education. Applying what
you have learned about the theory of compensating differentials,
answer the following questions:
a) Plot the map of individuals indifference curves. Explain the
shape of the curves.
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b) Plot the indifference curves of two individuals with
different aversion degrees for investing in education. What could
explain these differences between individuals?
c) Plot the iso-profits curves. Explain their format and
identify the relevant iso-profit.
d) Comment the following statement: The slope of the iso-profit
may differ from firm to firm.
e) Explain and plot the market equilibrium. f) As you have seen
from classes, the Human Capital Theory and the Theory of
Signaling have different perspectives on the role of education.
Does the previous analysis allow you to give a definitive answer
about which theory is right?
Question 3.
a) Represent graphically the indifference curves of two
individuals with different aversion degrees to investment in
education. Justify. What reasons can explain these different
degrees of aversion?
b) Suppose a market where education is not valued by firms,
i.e., firms are indifferent between individuals with more or less
education. Plot the iso-profit curves and adequately explaining the
shape of the curves.
c) Explain and represent graphically the market equilibrium.
Question 4.
Consider the following picture:
In the absence of regulations on the risk of accident, the
situation in the market is the one represented above. Assume now
that the Government imposes a rule that sets the
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maximum level of risk in Rmax. Explain in detail, using the
economic concepts discussed during classes, the effects of this
rule on individuals and on firms.
Question 5. Depressions and new cancers are the diseases of the
decade (...) The increase of psychosocial diseases is one of the
alerts of ACT (Autoridade para as Condies de Trabalho) for the
National day of Prevention and Safety at Work, which is celebrated
today. One of the slogans will be also protect you against what you
do not see. (...)
Source: www.ionline.pt; 08/04/2010 Comment the excerpt and the
motto: also protect you against what you do not see according to
the Theory of Compensating Wage Differentials and its assumptions.
Question 6. The additional wage premium earned by the workers with
more education may be seen as a compensating wage differential. In
this context assume a scenario with two workers and two firms and
assume that in equilibrium the worker A decides to do the six years
of schooling and worker B chooses 9 years of schooling. Analyze the
impact on workers and on firms of a mandatory schooling policy of
12 years. Plot and compare the equilibrium before and after the
introduction of the policy. Question 7.
Consider the theory of compensating wage differentials with
respect to the choice between wage and the risk of accident.
a) Represent graphically the market equilibrium, identify and
explain what constitutes the compensating wage differential.
Justify.
b) Describe the assumptions on which the theory of compensating
wage differentials is based.
c) Discuss the following statement: "By distorting the market
equilibrium, the introduction of mandatory rules on hygiene and
safety at work will reduce welfare."
Question 8. Consider the theory of compensating wage
differentials applied to investment in education:
a) Explain and represent graphically the offer curve. b)
Represent graphically the indifference curves of two individuals (A
and B) in
which the individual A has a higher degree of aversion to
investing in education. Discuss the reasons that may explain this
difference between individuals?
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c) Explain in detail and represent graphically the market
equilibrium knowing that one of the individuals will complete 9
years of schooling and the other will complete 17 years of
schooling.
d) Consider the following news: Mandatory schooling changes to
12 years The Council of Ministers approved on Thursday, generally
the proposed law that extends from nine to 12 years of mandatory
schooling (...)
Source: http://aeiou.visao.pt, April 23, 2009 What is the impact
of this public policy on the market equilibrium and on the
well-being of individuals A and B? Justify your answer and
represent graphically. Question 9. Risk subsidy and performance
evaluation lead municipal workers to the streets of Lisbon The
failure to update the subsidy for unsanitary, painfulness and risk
and an alleged "unfair treatment" in the application of performance
evaluation by the Lisbon municipality motivated today two different
concentrations of workers. From 09:30, the Union of Workers of the
Municipality of Lisbon is waiting for more than five hundred
employees in front of Paos do Concelho to claim for an increased
risk subsidy, which they claim to be out of date since 2002.
Source: www.ionline.pt; 24 de Fevereiro de 2010
Comment and justify your answer graphically: The payment of a
subsidy for unhealthy conditions, hardship and risk always benefits
workers. Question 10. On the labor market for the perfume industry
workers like the smell of perfume since this is not too intense and
exaggerated. It is known that to reduce the smell of perfume in the
workplace, the firm has to support an extra cost facing an
increasing marginal cost with the reduction of the smell.
a) (2 points) Represent graphically the indifference curves of a
typical worker. Explain the shape of the curves.
b) (2 points) Represent graphically the isoprofit curves.
Explain their format and identify the relevant isoprofit.
c) (2 points) Explain and represent graphically the market
equilibrium. Is there any the compensation wage differential.
Justify your answer.
Non-monetary Compensation Question 1. Suppose Congress were to
mandate that all employers had to offer their employees a life
insurance policy worth at least $50,000 in the event of death. Use
economic theory to analyze the effects of this mandate on employee
well-being.
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Question 2. Taking into account the theory of compensating wage
differentials and the choice between monetary and non-monetary
compensation, read the following article: Nearly 800,000 Portuguese
have health insurance paid by firms PPR (pension plans) are also a
way to reward workers Firms are increasingly focusing on other
components of remuneration besides the wage. Health insurances are
a good example. At this time, there are about 660-800 thousand
Portuguese who benefit from these insurance paid by the employer.
(...) People are aware that their income is not just wage, but also
and increasingly protection in health and social security (like
pension plans)
Source: www.agenciafinanceira.iol.pt; January 27, 2009
a) Represent graphically the indifference curves of two
individuals with different preferences regarding the choice between
wages and non-monetary benefits. Justify.
b) Suppose that a firms isoprofit has a constant slope that is
equal to -2. Represent graphically the isoprofit and interpret the
slope.
c) Explain and represent graphically the market equilibrium
assuming that the previous firm is representative of the
market.
d) Assume that a firm decided to substitute the payment of
health insurance for a pension plan (PPR). What can explain this
change in the firms policy and what is the likely impact on the
slope of the isoprofit.
Question 3. Choose the one alternative that BEST completes the
statement or answers the question:
1. Workers indifference curves for wage rates versus benefits
will be: (a) downward sloping. (b) upward sloping. (c) downward
sloping and concave. (d) upward sloping and convex.
2. Introduction of a benefit that turns out to decrease
productivity would cause a
firms iso-profit curve to (a) flatten. (b) become steeper. (c)
remain unchanged. (d) become convex.
3. High-paying jobs are also associated with generous benefits
because (a) benefits which cost $100 generally increase utility by
more than $100 in
cash. (b) high-paid workers can benefit from the tax advantages
given to benefits. (c) employers know how to spend money better
than their employees. (d) high-paid workers are risk neutral
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4. A firm offers the optimal mix of wages and benefits. It is
paying $5 an hour in wages and $3 in benefits. The minimum wage is
then increased from $5 to $7 an hour. Assume all workers have the
same utility curves (and have the usual shape). If the firm
continues to spend $8 an hour on workers, then
(a) workers will be better off (b) workers will be as well off
as before. (c) workers will be worse off. (d) it is impossible to
determine if workers are better or worse off without
knowing if benefits are a normal or inferior good. Question 4.
Classify the following statements as true or false, always briefly
justifying your answer:
1. (1 point) The introduction of a health insurance
(non-monetary remuneration) may increase the slope of firms
iso-profit.
2. (1 point) In the presence of progressive taxes, individuals
prefer the non-
monetary compensation to monetary compensation.
Question 5. What is the importance of the tax factor in the
choice between monetary remuneration and non-monetary
remuneration?
Variable pay Question 1. Consider a worker that produces shirts.
If his compensation was not affected the worker would prefer to
work at an easy pace. The worker views his cost per hour (C) of
producing shirts (S) as given by:
C = a Sb
The firm is considering the payment of a piece rate, i.e., a
certain amount per shirt. The workers compensation (W) is given
by:
W S
A shirt sells for 20a (to simplify, suppose there are no other
costs of shirt producing).
a) Discuss reasonable values for the parameter b. Justify. For
the following questions suppose that b=2
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b) Graph and interpret the function C. c) Graph and interpret
the workers supply of shirts. d) How many shirts does each worker
produce? What is the optimal
compensation policy? e) What is the level of profit per worker
per hour?
Question 2. From May to July, Florinda works in cherry picking
at the firm Cerejovski, Inc. Her job is to pick cherries and put
them in baskets. The cost (C) associated with the effort required
in this activity is given by:
2
21 XC
The firm Cerejovski, Inc decided to pay its workers based on the
number of baskets of cherries harvested, i.e.:
XW Each basket of cherries is sold in the Cherry Cooperative for
5. Besides the wage costs (W) the only additional cost to the firm
is the price of the baskets which is 1 euro per unity.
a) How many baskets of cherries will Florinda fill per hour?
What is the optimal remuneration policy for the firm Cerejovski,
Inc?
b) Assuming that the firm hired 10 workers identical to Florinda
in all characteristics and that work 6 hours per day, which is the
firms daily profit?
c) The firm is considering changing its remuneration policy to
paying a fixed hourly wage to their workers. Discuss the advantages
and disadvantages of each of the remuneration systems. Which system
seems most suitable for the firm?
Question 3. Firm ABC, Inc. chose to pay their workers according
to the quantity produced per hour, that is:
W X . The cost associated with the effort required in this
activity is given by:
2C(X) aX Where X is the quantity produced per hour. The Human
Resources Department concluded that the optimal remuneration is as
follows:
W 1 X
a) Given that the optimal quantity produced per hour is 2 units,
determine the parameter a.
b) Interpret the parameter . Compare this result with the
strategies that companies adopt in practice.
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c) Interpret the parameter . Compare this result with the
strategies that companies adopt in practice.
Question 4. John is a bookseller at the firm Crculo de Leitores
and works on commission. He faces a daily cost (C) associated with
the sale of each book (L) given by:
C = 1/2 L2
Johns wage (W) depends on the number of books sold according to
the following relation:
W = + L
The average selling price of books is 15 and there are other
non-wage costs associated with firms operation in the amount of 10
per book.
a) Determine the number of books sold by John, the remuneration
policy and the optimal profit per employee for the firm Crculo de
Leitores. Justify your answer.
b) Explain why, usually, commissions are based on sales and
determine its value. Justify.
Question 5. Choose the one alternative that BEST completes the
statement or answers the question:
1. One problem with pay for performance is that (a) it provides
incentives for workers to put forth effort. (b) workers are
risk-averse. (c) supervision is very expensive. (d) workers are
income maximizers.
2. Pay for performance works LEAST well for an employee (a) who
works as a counselor for other employees in a company. (b) who is
closely supervised. (c) who maximizes utility. (d) whose value
added is easily measured.
3. Which of the following types of pay is NOT linked to
output?
(a) commissions (b) profit sharing (c) hourly wages (d)
piece-rate pay
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4. Many employees prefer to be paid on the basis of
(a) output, because it decreases variation of wages. (b) time,
because it decreases variation of wages. (c) output, because it
increases variation of wages. (d) time, because it increases
variation of wages.
5. The workers who will prefer piece-rate pay will usually
be
(a) less present-oriented than average. (b) less motivated than
average. (c) more productive than average. (d) more risk-averse
than average.
6. Workers who are paid on a piece-rate basis tend to
(a) work quickly. (b) have a high regard for quality. (c)
require close supervision. (d) work well as members of a team.
Question 6. Classify the following statement as true or false,
justifying your answer: It is preferable for workers that the
commissions are based on the sales and not on the profits.
Question 7.
Discuss in what circumstances the firms should opt by a variable
remuneration and in which situations it is preferable to opt for a
fixed remuneration. Question 8. Carefully read the text No variable
pay for TCS trainees during training period Tata Consultancy
Services (TCS), Indias top software exporter has announced that
fresh recruits will not be eligible for variable pay during their
training period of six months.() Ajoy Mukherjee, Vice President and
Head of Global Human Resources of TCS, has said that the
compensation re-structuring is primarily from a productivity point
of view.()
Source: www.topnews.in; September 17, 2009
a) Identify the type of compensation referenced in the text and
discuss the advantages and disadvantages of this type of incentive
system.
b) Taking as a framework the theory on who should pay for the
training comment the text above. Discuss the policy implemented by
TCS giving particular emphasis to the argument outlined at the end
of the text. Illustrate graphically and justify your answer.
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Promotions
Question 1. The firm Soft, SA produces computer software. The
administration intends to build a hierarchy of functions that allow
their employees to progress in their careers within the company
(internal labor market). Nowadays, the human resources department
is studying the wages of two professional categories: technician
and supervisor.
Assessing the relative performance of employees at end of
period, the administration will promote the individual that is more
productive. The average selling price of the firms product is 5
m.u. and the quantity produced by each individual is given by:
q q quantity; effort
- luck: random factors that the worker cannot control. At the
moment there are two candidates to the post of supervisor: John (j)
and Carla (k) and it is known that, for both, the cost associated
with effort is given by:
2C( )
It is known that the random variable k j uniformly takes values
between 21
and
21 .
a) The human resources department is considering the following
hypotheses:
Hypothesis 1: Supervisor W1 = 9 m.u. Technical W2 = 3 m.u.
Hypothesis 2: Supervisor W1 = 12 m.u. Technical W2 = 6 m.u.
For each of the hypothesis considered, compute:
1. The expected output per woker. 2. The profit of the firm.
b) Answer to the above questions again assuming that the average
price of the
firms product increases to 6 m.u.
Technician
W1 = ? Supervisor
W2 = ?
()
() Figure 1: Excerpt from the job ladder firm Soft, SA
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c) Both tournaments and piece-rates are strategies used by firms
to motivate and encourage the efforts of workers. Discuss under
which circumstances the tournaments are preferable to
piece-rates.
Question 2. The firm ABC Ltd. is deciding the wages of two
professional categories: chief (W1) and commissioner (W2).
Assessing the relative performance of the employees, at end of
period, the firms management will promote to chief the most
productive individual. The firm has two candidates, workers j and
k, and it is known that for both the cost associated with effort is
given by:
2C( ) 2 The final price of the firms product is 2 m.u. and the
output per individual is given by:
2q q quantity; effort;
- luck: random factors that the worker cannot control.
It is known that the random variable k j uniformly takes values
between 81
and 81 .
a) Determine the expected output per worker, the premium and the
wage rate that
has to be paid to each of the occupational categories. b)
Compute the firms profit. c) Suppose now that the random variable
is taking values uniformly between -1
and 1. Without doing any further calculations, explain what will
happen to the premium paid by the firm.
Question 3. John (j) and Carla (k) compete to a promotion at
firm Soft, SA. Assessing the relative performance of employees at
end of period, the firms management will promote the most
productive individual.. The promoted employee will earn a wage of
W1 while the other will receive only W2 . The average selling price
of the firms product is 6 and the quantity produced by each worker
is given by:
q = 2u + where q is the quantity, u is the level of effort and
is a random variable that represents luck, that is, random factors
that the worker cannot control. The effort cost for each worker is
given by:
C(u) = 2u2
Suppose that the random variable (k- j) can assume one of the
following structures: [A] Uniform distribution, taking values
between -1 and 1; [B] Uniform distribution, taking values between -
and .
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a) In which of the hypothesis to the shape of the density
probability function of the variable luck, [A] or [B], one can
conclude that it will have a higher importance in the outcome of
the tournament? Justify.
To answer to b) and c) assume the hypothesis [B] as the
sturcture for luck:
b) Determine and represent graphically the effort supply
function of each worker. c) Determine the optimal wage strategy,
the optimal level of effort and the total
profit of the firm. d) Without doing calculations, explain what
would happen to the value of the
premium and to the average wage level paid by the firm if we
assumed the hypothesis [A] as the structure for luck.
Question 4. In the promotion model, the tournaments winner is
determined by the effort expended by workers but also by luck, or
by other random factors beyond the control of individuals."
Discuss the excerpt explaining how the importance of luck
affects the average wage paid by firms. Question 5. Carefully read
the text: A university degree is almost essential for entering the
aerospace industry - particularly for science or engineering roles.
Diploma qualifications may secure apprenticeship positions, but
pathways up the job ladder for these candidates will be slower and
limited compared with university graduates.
Source: www.aerospace-technology.com Identify the type of
incentive referenced in the text and discuss the advantages and
disadvantages of this type of incentive system. Question 6.
Considering the promotion model presented in classes, discuss the
impact of the following scenarios (assuming everything else remains
constant) in the premium and in the density probability function of
the variable k j :
a) The luck factor becomes less important; b) The reservation
wage of workers decreases.
Justify your answers.
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Question 7. Classify the following statements as true or false,
always briefly justifying your answer:
1. In the tournament model, if workers are heterogeneous the
optimal level of effort will be reduced when compared to the
situation in which individuals are homogeneous
2. In the tournament model, a way to avoid collusion of
candidates that can lead to the reduction of effort is the
existence of many candidates to promotion.
Seniority and efficiency wages Question 1. 100 years ago, Henry
Ford announced the five-dollar day, sharply increasing the price
that he was willing to pay for the work in his car company.
Although increasing wages is not usually the first thing we think
about when we want to cut costs, Fords strategy has generated
significant savings for his company (...) "
Source: www.fangraphs.com Discuss the excerpt explaining how
Fords strategy has generated significant savings for his company.
Question 2.
a) Provide a concrete example in which piece-rates are
preferable to a remuneration based on seniority and another example
where there the opposite occurs. Justify.
b) Discuss the following statement: The payment of a wage above
productivity only occurs when productivity depends on the wage,
i.e., in the model of efficiency wages.
Question 3. Choose the option that BEST completes the statement
or answers the question: 1. Suppose a firm has implemented a
remuneration system that depends on the seniority
of the employees in the firm. Which of the following statements
is true? a) None of the statements is correct. b) At an early stage
of the employment relationship the firm pays a wage above the
workers marginal productivity and later pays a wage lower than
the productivity to recover the investment made in the
employee.
c) This type of compensation attracts workers who are more
interested in staying in the firm for a long period inducing thus
adverse selection.
d) Contrary to what happens with a variable compensation system
based on output, in periods of economic recession such remuneration
system does not involve any risks to workers.
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2. Relatively to the model of efficiency wages, which of the
following statements is correct?
a) The value of the efficiency wage is lower the lower is the
unemployment rate in the economy.
b) All statements are correct. c) This model allows to justify
the existence of voluntary unemployment in
equilibrium. d) This incentive system is suitable when workers'
productivity depends on the
wage. Question 4. Classify the following statements as true or
false, always briefly justifying your answer:
1. The existence of segmented labor markets or dual may result
from the fact that only a few firms pay efficiency wages.
2. The remuneration of the type W q is preferable to a
remuneration based on seniority.
3. In the presence of economic recessions, the payment of a
remuneration based on seniority has increased risks for
workers.
Question 5.
What are efficiency wages? What is their main goal? Question 6.
Comment carefully the following statement presenting three examples
that support it: The worker throughout his career, may experience
periods where their marginal productivity differs from the
wage.