3. Labour Economics

Question 1

Properties of indifference curves

Answer 1

1. Each higher indifference curve corresponds to higher utility
2. Indifference curves don’t intersect
3. The slope is the MRS between consumption and leisure
4. Convex shape

Question 2

Equation for budget constraint

Answer 2

C=-wL+ (WLo+ R)

Question 3

What is true at an interior solution?

Answer 3

W=MRS

Slope of BC and indifference curve are the same

Question 4

If MRS>W at (Lo,R) what happens?

Answer 4

The person doesn’t work at all since the wage is lower than their reservation wage

Question 5

If MRS

Answer 5

The person will work more

Question 6

What happens to the reservation wage if non labour income increases?

Answer 6

The reservation wage increases

Question 7

Describe the slopes of a laid back person and a workaholic

Answer 7

Workaholic has flat slope since they are willing to sacrifice a lot of leisure for a little extra consumption. Laid back person has steeper slope

Question 8

Income effect

Answer 8

How a change in demand of a good is affected by a change in real disposable income. Wealthier following wage rise so consume more leisure

Question 9

Substitution effect

Answer 9

How change in the demand of a good is affected by a change in price of that good. Higher wage means leisure is more expensive, as the opportunity cost is working

Question 10

What do the income and substitution effect do when wages rise?

Answer 10

• income effect causes rise in leisure

* substitution effect causes fall in leisure

Question 11

What is a convex function?

Answer 11

Any function where a straight line between any two points contained in the set stays contained in the set

Question 12

Steps to solve a question with a non convex budget constraint

Answer 12

1. Compute MRS
2. Look for interior solutions on each section of the slope
3. If there are no interior solutions, work out utility at kinks and see which one is largest, this is a solution. Remember there may be multiple solutions

Question 13

What determines search frictions?

Answer 13

The state of the labour market

Efficiency of search process

Question 14

What are the inefficiencies which explain why there are vacancies and unemployed people?

Answer 14

• unemployed are in different location to jobs
• unemployed have different skills than job
• information problems

Question 15

What is the matching function?

Answer 15

It is a function which relates to the number of workers hired per unit time based on the two inputs of number of employed and number of vacancies

Question 16

In a constant returns to scale cobb Douglas what is the homogeneity?

Answer 16

The function is homogeneous of degree r

Question 17

Market tightness

Answer 17

The market tightness describes the state of the labour market with reference to unemployment and vacancies

Question 18

What is the ratio of vacancies to unemployed people if the market is doing well?

Answer 18

There are lots of vacancies for every unemployed person

Question 19

What is a desirable feature of the Cobb Douglas matching function?

Answer 19

Empirical tractability

Question 20

What is a steady state?

Answer 20

A period when unemployment is constant

Question 21

What is needed for there to be a steady state?

Answer 21

Outflow of unemployment must equal inflow of unemployment

Question 22

What are the two ways the unemployment rate can be computed given a steady state

Answer 22

• from the stock- simply count the number of unemployed at period t in the data
• from the flow- compute the rate at which unemployed find and lose their jobs and compute Ut

Question 23

What is the urn ball game?

Answer 23

There are two identical workers and two identical firms. Each firm can only employ one worker

Question 24

Coordinated equilibrium of urn ball game

Answer 24

When the workers discuss with one another or move sequentially

Question 25

If both wages are identical what is the strategy of both players?

Answer 25

They randomise between each job with probability 0.5 on each one

Question 26

Congestion externality

Answer 26

The fact that A doesn’t know which job player B has applied for, this is an informational friction

Question 27

If the wages are equal at both jobs what is the employment rate?

Answer 27

Employment =0.75

Question 28

Why might the firm pay more than market clearing wage?

Answer 28

• increase health and therefore productivity
• inability to monitor workers effort- high wage makes losing a job a real punishment for low effort
• attract higher skilled workers
• high wages build loyalty among workers reducing turnover

Question 29

What is necessary to prevent a worker from shirking

Answer 29

The payoff from exerting the required effort must be greater than the payoff from shirking

Question 30

What do greater outside option imply about wages?

Answer 30

Higher outside options imply higher wages

Question 31

What does the cost of effort imply about wages

Answer 31

The higher the cost of effort implies higher wages

Question 32

How does the probability of being caught affect wages?

Answer 32

The higher the probability of being caught the lower the wages

Question 33

In what industries are wages highest

Answer 33

Industries where
•workers have strong labour demand for their skill set
•it’s hard work
•individual output is hard to measure

Question 34

When there is a trade union how do we find the equilibrium wage and labour level?

Answer 34

Create an extensive form game where the trade union offers any wage and for each wage the firm can either accept or reject? Use backwards induction to find equilibrium