Heather Krull / Midterm 2
Econ 190 / November 7, 2003

Name: ______

Instructions:

1.  Write your name above.

2.  No baseball caps are allowed.

3.  Write your answers in the space provided. If you need additional room, you may continue answers on the back of the last page of the exam. Be sure to indicate that answers are continued and carefully identify any work that carries over.

4.  Be sure to show your calculations and other work to receive (partial) credit.

5.  After you have completed the exam, sign the Honor Code statement at the bottom of the last page.

Definitions (3 points each):

1.  Isoquant:

2.  Ability Bias:

3.  Marginal Rate of Return to Schooling (formula and word definition):

Short Answer/Applications (39 total points):

1.  (16 points) Consider a perfectly competitive firm with the following production function: . This production function yields the following marginal product functions: and .

  1. Assume initially that the firm is in the short run with 64 units of capital. Additionally, assume the firm’s output sells at a price of $3, and workers are paid $74 per day. Complete the following table (2 points) and use it to answer the questions below (for simplicity and accuracy, I suggest you round your calculations to two decimal points).

E / MPE / VMPE
0 / - / -
1
2
3 / 27.73
4
5
6 / 66.04
  1. (2 points) How many workers will the firm hire? What condition determines the optimal quantity of labor?
  1. (4 points) Calculate the short-run elasticity of labor demand if the daily wage rate changes to $81. Describe what this elasticity means (in other words, interpret it as we’ve done in class). Is this firm’s demand for labor elastic or inelastic?
  1. (8 points) Assume now that the firm is in the long run. Further, suppose the firm now hires labor and capital at daily rates of $50 and $75 respectively.
  1. (4 points) Is an input combination of 5 machines and 20 workers optimal? If not, how should the firm adjust its input quantities? Explain. (Note: For the second part of this question, I would expect answers such as “the quantity of capital should decrease,” for instance, not exact quantities.)
  1. (4 points) If the firm is initially optimizing and the price of capital increases, how will the firm adjust its quantities of labor and capital? Can we determine unambiguously how the quantity of labor will change? Capital? Be sure to include in your answer which effect(s) cause the changes you describe, and explain/define the effect(s). Again, this answer should be qualitative, not quantitative.


w
E

2.  (8 points) What happens to wages and employment if the government imposes a payroll tax on a non-discriminating monopsonist? Illustrate graphically and describe the decisions the firm makes. Compare the responses in the monopsonistic market to the responses that would have been observed if the market were competitive.

3.  (10 points) Consider a firm that hires low-skilled workers. The firm’s labor demand curve is given by: wD = 16-0.1E, and the supply of low-skilled labor is represented by the following equation: wS = 0.3E - 32. To stimulate the employment of low-skilled workers, suppose the government institutes a wage subsidy program. The program is a “targeted” subsidy in that the firm will receive a subsidy only if it hires people previously on welfare. The subsidy will be structured so that the firm receives 50 percent of the difference between the wage they pay and the program’s target wage of $8. Thus, if the firm pays the workers $8 or more, it receives no subsidy.

  1. (2 points) Before the subsidy was enacted, what was the quantity of labor demanded? What was the equilibrium wage rate?
  1. (3 points) Under the program, what subsidy does the firm receive for each employee? Calculate the new equilibrium wage and employment level.
  1. (3 points) What is the new per-unit cost of labor to the firm? What percentage of the subsidy is enjoyed by the worker? What percentage is enjoyed by the firm?
  1. (2 points) Offer two explanations for why subsidy programs targeted to specific groups do not always have the type of effect this example predicts.

4.  (7 points) Suppose one year of schooling costs $10,000 for high-ability workers and $15,000 for low-ability workers. Firms are willing to pay $100,000 (in total for the duration of this problem) to those whom they consider high-ability workers and $40,000 to low-ability workers.

  1. (4 points) How much schooling will each type of worker acquire? How much will firms pay low-ability workers? High-ability workers?
  1. (3 points) Suppose instead that one additional year of schooling costs $20,000 regardless of ability, and firms only know that 55% of the population is considered high-ability, and 45% is low-ability. How much schooling will each type of worker acquire? How much will firms pay low-ability workers? High-ability workers?

HONOR CODE PLEDGE: I affirm that I have neither given nor received aid on this exam. ______

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