ECON 280 Alexander College Labour Economics Problem Solution
ProblemsAssume that you are deciding whether to acquire a four-year university degree. Your only consideration at this moment is the degree as an investment for yourself. Costs per year are tuition fees of $600 and books at $100. The government also pays to the university an equivalent amount to your tuition fees to cover the real cost. If you didn’t go to university, you could earn $6000 per year as an acrobat. With a university degree, however, you know that you can earn $10,000 per year as an acrobat. Because of the nature of your chosen occupation, your time horizon for the investment decision is exactly 10 years after university; that is, if the investment is to be worthwhile, it must be so within a 10-year period after graduation. The market rate of interest is 5 percent. Would you make the investment in a degreeMadeleine is a high school graduate deciding whether to go to university. She (like everyone else) lives for two periods after high school. In the first period, she can work (without university) for a salary of YH, or she can attend university. If she attends university, she must pay $5000 in fees (tuition, books), but she will also earn $5000 from a summer job. In the second period, she will continue to earn YH if she did not attend university, or she will earn YU if she went to university. The interest rate at which money can be borrowed or invested is r.Show that she will attend universitYAssume that there are two types of workers in equal proportion (i.e., 50 percent of each type). High-ability workers have productivity of $50,000, while low-ability workers have productivity of $30,000. Firms will pay workers their marginal product, but they cannot distinguish between the two types of workers. If firms cannot distinguish between workers, they must pay all workers the same wage, equal to the average marginal product. In equilibrium, firms must earn zero profits.However, workers can buy S units of education. The cost to high-ability workers of acquiring S units of education is $S/2, and for low-ability workers, it is $S. Education has no impact on workers’ marginal products.What is the equilibrium wage rate for the high- and low-ability workers in the absence of education; that is, assuming that education is unaffordable to either the high- or the low-ability workers?Now assume that education is available as described. Assume that firms use the following rules to pay workers:If S < 31,000, then pay the worker $30,000If S ≥ 31,000, then pay the worker $50,000How much education will the high- and low-ability workers obtain, and what will be their wages? Provide a careful explanation and diagram.Returning to the theoretical model, in an effort to encourage low-ability workers to obtain schooling, the government subsidizes and reforms education so that the cost of schooling is reduced. The cost to high-ability workers is now $S/3, and to low ability, $S/2.Show that the pay scheme adopted by firms in part (a) does not yield an equilibrium. What is the equilibrium level of schooling and education?Why might large firms pay higher wages than small firms? Why might this relationship prevail even after controlling for the effect of other wage-determining factors, such as the differences in the skill distribution and in working conditions?Grant, a young Newfoundlander, has just graduated from high school and is deciding what to do with the rest of his life, which lasts two periods (like everyone else’s). His main decision is whether to stay in Newfoundland or migrate to Toronto. If he stays in Newfoundland, he will earn Y0 in period 1 and Y1 in period 2. If he moves to Toronto, he will incur a moving cost of M (in the first period), and he will be unemployed (with zero earnings) for the first period. In his second period in Toronto, he will earn YT. The interest rate at which money can be borrowed or invested is T.On a carefully labelled diagram, illustrate Grant’s migration decision; that is, show his earnings paths as a function of time, depending on whether he lives in Newfoundland or Toronto.Show that he will move to Toronto ifWhat is the economic intuition underlying this result? How does an increase in the interest rate affect the migration decision? Why?As a potential labour economist, Grant realizes that he needs to have estimates of YT and Y1 in order to make a wise migration decision. He reads in the newspaper that average earnings of Newfoundlanders in Toronto are , while Newfoundlanders earn an average of if they stay in Newfoundland. (Both magnitudes refer to second-period earnings) With specific reference to the result in part (b), discuss the potential error that Grant may make by using and as the basis of his estimate of the return to migration.Assume that, on average, an applicant waits 12 months before being hired into a government job (as a mail clerk). George could work as a mail clerk in the private sector immediately for a salary of $2500 per month, but he chooses instead to remain unemployed and wait for the government job. In the meantime, he collects $500 per month in unemployment insurance benefits (for 12 months). Assume that the government job lasts two years, that his private sector job will last just as long (plus the year he can wait for the government job), that salaries are constant, that the interest rate is 10 percent per year, and that leisure has no value to George. Determine the minimum public sector premium that must exist for George’s decision to be rational.Page 299What are the pros and cons of using queues as a measure of rents or excess payments paid to workers in the public sector?
