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ECO 341 Homework 2 Assignment (Fall 2014) Solution.................................................




Question;1. An increase in the wage can cause an increase in leisure when the substitution effect (of thechange in wage on leisure) is positive. True/false/explain.2. Assume that there is only one earner in a family and that she can earn $10 an hour. There are100 hours a week available for work or leisure. There are 50 work-weeks per year. The welfareprogram provides $10,000 per year if she has zero earnings. For every dollar earned, her welfarecheck is reduced by 25 cents. For example, if she earns $10,000 from work, she receives $7500from the welfare program. Use wage = $10. If she earns $40,000 or more, she is not eligible toreceive welfare payments.a. Draw the annual budget constraint for this family in the absence of a welfare program. Next,add a budget constraint that reflects the existence of the welfare program. Label clearly.b. Use a new graph to show that, without the welfare program, the earner would maximize utilityby working 40 hours per week (2000 hours per year). Show total hours of leisure and total hoursof work per year. What are yearly earnings?c. Use a new graph (of annual numbers again). Add the welfare program to the graph you drewin (b) and show the utility-maximizing combination of leisure and consumption at 30 hours ofwork per week (1500 hours annually). What are yearly earnings? What is the effect of thewelfare system on the well-being of the family? Geometrically speaking, why does the model notpermit pre-welfare and post-welfare hours worked to be the same? What worker characteristicwould have to change to make the same hours of work possible before and after the welfareprogram?d. Now assume that, without the welfare program, the earner would choose to work 20 hours perweek. How much does she earn per year? How many hours will she choose to work per yearwhen she has the option of receiving welfare? Show on a new diagram.3a. What happens to the firm?s long-run labor-demand curve if the demand for the firm?s outputincreases? Explain in words--no graph required.b. What happens to the firm?s long-run labor-demand curve if the price of capital decreases?Explain, using the isoquant-isocost model.4. Consider a firm for which production depends on two normal inputs, labor and capital, withprices w and r, respectively. Initially, the firm faces market prices of w = 12 and r = 8. Then thewage rate falls to 8 and the rental rate on capital falls to 4.a. In which direction will the substitution effect change the firm?s employment of labor andcapital? Explain in words.b. In which direction will the scale effect change the firm?s employment of labor and capital?Explain in words.c. Can it be conclusively determined whether the firm will use more or less labor? More or lesscapital? Explain your answer in words.5. Suppose a firm hires labor in a competitive labor market and sells its output in a competitiveproduct market. The firm?s elasticity of demand for labor is -0.4. If the wage increases by 20percent, what will happen to the number of workers hired by the firm? What will happen to themarginal productivity of the marginal worker hired by the firm?6. Union A wants to represent workers in a firm that would hire 2,000 workers if the wage rate is$12 and would hire 1000 workers if the wage rate is $15. Union B wants to represent workers ina firm that would hire 3000 workers if the wage rate is $20 and would hire 3300 workers if thewage rate is $15. Which union is more likely to be successful in organizing? Explain.7. Suppose that some enterprising students open Cookies R Us, a cookie factory, in an unusedarea of one of the dorms. They employ eight workers, paying each worker $8.00 per hour. Theycharge $1.00 per cookie.a. Assume that CRU is a price-taker that is maximizing profits. According to the short-run modelof a profit-maximizing firm, what is the hourly marginal product of the last worker hired?b. One of the student-owners invents a process that doubles the marginal product of labor. Usinga supply and demand model of the cookie market (and your extensive knowledge ofmicroeconomic principles), what effect would be expected on the price of cookies from thetechnological innovation?c. Given the increase in productivity and your answer in (b), what effect will this new processhave on the wage in the market for cookie makers? Use a model of the labor market in youranswer.


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