Labour Economics (BSc) – Fall 2019 Exam

Instructors: Costanza Naguib and Michele Pellizzari

Teaching Assistant: Clemente Pignatti

Instructions: You have 2 hours to complete the exam. You can use the booklet of papers provided to you to derive

the solutions, but the answers need to be reported on the answer sheet. There is only one correct answer for each

question. You obtain a point of 1 for each correct answer and a penalty of -0.25 for incorrect answers. You can use

only a calculator, but your phone cannot be used as a calculator. Any attempt of cheating will result in the immediate

expulsion from the room. Good luck with the exam!

SHORT QUESTIONS

1. Which of the following definition best describes a panel database?

(a) An individual is observed repeatedly over time

(b) The same group of individuals is observed repeatedly over time

(c) A group of individuals is observed once

(d) Different groups of individuals are observed at different points in time

Solution: Correct answer is b.

2. According to the model of efficiency wages (Shapiro and Stiglitz, 1984), an employer finds it optimal to pay a

wage above the market wage:

(a) To differentiate between high- and low-skilled workers

(b) To incentivize workers to acquire education

(c) To incentivize workers to exert effort

(d) For high-skilled workers to self-select into high-skilled jobs

Solution: In the model of efficiency wages, output depends on workers’ effort which is only imperfectly

observed by the employer and is costly to the worker. Employers might then find optimal to offer a higher

wage, such that if the worker shrinks and looses her job she can only earn a lower wage in an alternative job.

Correct answer is c.

3. Everything else being equal, individuals with a lower discount rate will:
Labour Economics (BSc) Academic year 2019-2020

(a) Acquire more education

(b) Acquire less education

(c) Acquire the same level of education

(d) It cannot be predicted from the theory

Solution: The higher the discount rate, the greater the preference for immediate consumption over delayed

consumption. Given that acquiring education has immediate direct and indirect costs, individuals with a

lower discount rate will be more likely to acquire education. Correct answer is a.

4. Does immigration reduce employment of the natives?

(a) Always

(b) Never

(c) Only if immigrants are substitutes to natives

(d) Only if immigrants are complements to natives

Solution: Immigration reduces the employment of natives only in case immigrants are substitutes to natives.

Even in that case, the effect is not one-to-one as new jobs are anyway created. Correct answer is c.

LONG QUESTIONS

1. Consider an individual whose preferences are described by U = C 1/2 L2 , where C denotes consumption and L

corresponds to leisure. The average price of the consumption good is p = 2, the hourly wage is w = 4 and the

amount of available time is t = 24. The individual has no source of non-labour income (v = 0).

(a) What is the slope of the budget constraint faced by the individual?

(a) 4

(b) -4

(c) 2

(d) -2

Solution: The slope of the budget constraint is equal to −w/p = −2. The correct answer is d.

(b) What is the optimal amount of consumption, leisure and hours worked chosen by the individual?

(a) L=19.2, C=38.4, H=4.8

Labour Economics (BSc) Academic year 2019-2020

(b) L=19.2, C=9.6, H=4.8

(c) L=18, C=9, H=6

(d) L=17.5, C=8.75, H=6.5

Solution: The optimazation problem is solved by equating the MRS (−4 C

L ) with the slope of the budget

constraint (-2). This leads to a relatonship between consumption and leisure of the form C = 21 L, which

we plot in the budget contraint (2C + 4L = 4 ∗ 24). Solving by L, we obtain L = 19.2, from which we

derive C = 9.6 and H = 4.8. The correct answer is therefore b.

(c) How would your answer to question (b) change if the individual now receives a source of non-labour income

equal to v = 10?

(a) L=21.2, C=10.6, H=2.8

(b) L=19.2, C=38.4, H=4.8

(c) L=18.6, C=9.3, H=6.4

(d) L=22, C=44, H=2

Solution: The utility function and the slope of the budget constraint have not changed from the previous
1
point, hence the relationship C = 2L is still valid. We plug this into the new budget constraint

(2C + 4L = 4 ∗ 24 + 10) to obtain L = 21.2 and consequently C = 10.6 and H = 2.8. The correct

answer is a.

(d) How would you interpret the result on labour supply obtained in point (c) in terms of income and substitution

effects?

(a) The income effect leads to a reduction in labour supply, while the substitution effect has the opposite

effect. The income effect prevails in this case

(b) The income effect leads to a reduction in labour supply, while the substitution effect has the opposite

effect. The substitution effect prevails in this case

(c) The income effect leads to a reduction in labour supply, while there is no substitution effect as the wage

rate has not changed in this case

(d) The income and substitution effect perfectly compensate each other

Solution: The correct answer is c.

(e) Returning to the situation initially described in point (a) (i.e. v = 0), what happens to the optimal choice

of the individual in terms of consumption, leisure and hours worked if the wage rate now rises to w = 8?

(a) L=18.6, C=9.3, H=5.4

(b) L=19.2, C=19.2, H=4.8

Labour Economics (BSc) Academic year 2019-2020

(c) L=20.4, C=10.2, H=3.6

(d) None of the above

Solution: With the new wage rate, the slope of the budget constaint changes to (−w/p = 4) which is

equated to the (unchanged) MRS ( 4C

L ) to obtain the new relationship between consumption and leisure

(C = L). This is plugged in the new budget constraint (2C + 8L = 8 ∗ 24) to obtain the solutions to the

optimization problem L = 19.2, C = 19.2, H = 4.8. The correct answer is therefore b.

(f) How would you interpret the result on labour supply obtained in point (e) in terms of income and substitution

effects?

(a) The income effect leads the individual to work less, while the substitution effect had the opposite effect.

The income effect prevails in this case

(b) The income effect leads the individual to work less, while the substitution effect had the opposite effect.

The substitution effect prevails in this case

(c) There are no income and substitution effects

(d) The income and substitution effect perfectly compensate each other

Solution: The income and substitution effect perfectly compensate each other in this case, while con-

sumption increases as a result of the higher wage.The correct answer is d.

(g) Returning to the situation initially described in point (a) (i.e. v = 0 and w = 4), consider that the government

now wants to introduce a subsidy to encourage employment. The interventions consists of a subsidy equal to

2 for each hour worked up to a maximum of 4 hours worked per day (i.e. if an individual works 5 hours, the

subsidy is obtained only for the first 4 hours worked). How would the budget constraint of the individual

change after the introduction of the subsidy?

(a) The budget constraint will not be affected by the introduction of the subsidy

(b) The entire budget constraint will move outwards by an amount equal to the subsidy (i.e. 2) and be

parallel to the previous budget constraint

(c) The budget constraint will present a kink for a level of L = 20. For levels of L < 20 it will be paralllel

to the previous budget constraint, for levels of L > 20 it will be steeper

(d) The budget constraint will present a kink for a level of L = 20. For levels of L > 20 it will be paralllel

to the previous budget constraint, for levels of L < 20 it will be steeper

Solution: The correct answer is c.

(h) Derive the new optimal levels of consumption, lesiure and hours worked after the introduction of the subsidy

for an individual that before the introduction of the subsidy was working more than 4 hours (remember that

w = 4, p = 2 and v = 0)
Labour Economics (BSc) Academic year 2019-2020

(a) L=18.8, C=9.4, H=5.2

(b) L=20.8, C=10.4, H=3.2

(c) L=19.2, C=9.6, H=4.8

(d) L=24, C=12, H=0

Solution: For an individual that before the introduction of the subsidy was working more than four

hours (corresponding to the individual optimization choices obtained in point b), the new budget con-

straint will look like 2C + 4L = 4 ∗ 6 + 20 ∗ 4. The MRS and the slope of the budget constraint will be

unchanged, leading to a relationship between consumption and leisure of the form C = 12 L. Solving the

optimization problem leads to L = 20.8 and therefore C = 10.4 and H = 3.2. The correct answer is b.

(i) How would your answer to point (h) change if the the subsidy was to apply to the first 6 hours of work, so

that the individual was working less than the subsidised hours of work before the introduction of the subsidy?

(a) L=19.2, C=14.4, H=4.8

(b) L=19.2, C=9.6, H=4.8

(c) L=18.6, C=13.95, H=5.4

(d) L=20.4, C=15.3, H=3.6

Solution: For an individual that before the introduction of the subsidy was working less than six hours,

the new budget constraint will look like 2C + 6L = 6 ∗ 24. The MRS is unchanged, but the slope of

the busget constraunt becomes −w/p = −3, leading to a relationship between consuption and leisure of

the form of C = 43 L. Substituting this into the new budget constraint, we obtain an optimal solution

corresponding to L = 19.2, C = 14.4 and H = 4.8. The correct answer is a.

(j) How the introduction of a subsidy for the first six hours of work is going to affect the distribution of individuals

around the choice of number of hours worked?

(a) There is not going to be any change in the distribution of individuals in terms of their choice of the

number of hours worked

(b) There is going to be a change in the distribution, which however cannot be predicted from the theory

(c) There is going to be a mass of individual distributed in the proximity of L = 18

(d) There is going to be a mass of individual distributed in the proximity of L = 6

Solution: The introduction of a subsidy for the first 6 hours of work is going to change the distribution

of individuals along the number of hours they work. Individuals that were working more than 6 hours,

will only experience an income effect that will lead them to reduce labour supply. Individuals that

were working more than 6 hours will experience an income and substitution effect, with a priori unclear

effects on labour supply. Finally, some individuals that were not working before the introduction of the
Labour Economics (BSc) Academic year 2019-2020

subsidy might now decide to enter the labour market. These movements will create a mass of individuals

distributed around L = 18. The correct answer is c

2. Consider a firm using only labour as input for production and producing a unique good which it sells at a price

p = 1 in a competitive market. The firm’s production function is given by Y = 25Lw − 41 L2w + 25Lb − 14 L2b with a

corresponding marginal product of labour equal to M P Lw = 25 − 12 Lw for white workers and M P Lb = 25 − 21 Lb

for black workers. The firm can hire both white and black workers, which have the same MPL. The wage rate is

equal to w = 15 for both white and black workers.

(a) What is the optimal level of black (Lb ) and white (Lw ) workers that the firm would hire?

(a) Lb = 30, Lw = 30

(b) Lb = 30, Lw = 20

(c) Lb = 10, Lw = 10

(d) Lb = 20, Lw = 20

Solution: The optimal level of employment is obtained by equating the MPL with the prevailing wage

rate (25 − 21 L = 15) and solving by L. This gives an optimal level of employment for black and white

workers equal to 20 for each group. The correct answer is d

(b) What is the profit that the firm will make from the hiring of black workers?

(a) 100

(b) 200

(c) 300

(d) 400

Solution: Profit level from black workers is obtained using the profit formula π = pY − wLb = 25 ∗ 20 −
1 2
4 20 − 15 ∗ 20 = 100. The correct answer is therefore a.

(c) What happens to the optimal level of employment of black and white workers if the employer develops a

prejudice against black workers, whereby the employer will act as if the marginal product of labour for black

workers is 3 units less than what it actually is?

(a) Lb = 14, Lw = 24

(b) Lb = 16, Lw = 20

(c) Lb = 18, Lw = 20

(d) Lb = 14, Lw = 20
Labour Economics (BSc) Academic year 2019-2020

Solution: The new MPL for black workers is going to be equal to M P Lb = 25 − 12 Lb − 3. To find the

optimal level of employment for black workers, this will need to be equated to the prevailing wage rate

(always equal to 15) and will result into Lb = 14. The MPL and the prevailing wage for white workers

are instead unchanged, so the optimal level of employment will still be Lw = 20. The correct answer is

d.

(d) How much profit does the prejudiced employer now make out of black workers (i.e. with the employment

level found in point (c) for black workers and keeping wages equal to 15)?

(a) 87

(b) 91

(c) 100

(d) 106

Solution: Profit level for black workers is obtained with the formula π = pY − wLb = 25 ∗ 14 − 14 142 −

14 ∗ 15 = 91. The correct answer is b.

(e) How much the wage rate for black workers needs to fall in order to guarantee their initial level of employment

of black workers (obtained in point (a))? Hint: remember that they are subject to a prejudice equal to 3

which enters in their MPL.

(a) 11

(b) 12

(c) 13

(d) 14

Solution: The initial level of employment for black workers was equal to Lb = 20. In order to find the

wage rate that will guarantee this employment level with a prejudiced employer, we need to solve the

equation 25 − 12 Lb − 3 = W with Lb = 20. Thi leads to a wage rate equal to w = 12. The correct answer

is b

(f) What is the profit level that the employer will make out of black workers under the wage and employment

conditions obtained in point (e)?

(a) 80

(b) 100

(c) 140

(d) 160
Labour Economics (BSc) Academic year 2019-2020

Solution: Applying the profit function to the new wage rate for black workers w = 12 with a resulting

level of employment Lb = 20, we obtain a profit equal to 160. The correct answer is therefore d

(g) Maintaining the wage level obtained in point (e) for black workers, immagine that the employer now removes

any prejudice against them. How many black workers would now hire?

(a) 22

(b) 24

(c) 26

(d) 28

Solution: Without prejudice, the employer will simply equate the M P Lb = 25 − 21 Lb ) to the new wage

level (w = 12). This will lead to an optimal level of employment of black workers Lb = 26. The correct

answer is c

(h) What is the profit level that the employer will now make out of black workers (under the employment and

wage conditions obtained in point (g))?

(a) 169

(b) 171

(c) 173

(d) 175

Solution: Pluging into the profit functions the relevant levels of employment Lb = 26 and wage w = 12,

we obtain a profit level equal to 169. The correct answer is a.

(i) Is the employer making more profits if she discriminates or does not discriminate against black workers?

(a) Discriminate

(b) Does not discriminate

(c) It depends on whether the adjustment occurs via wages or employment

(d) Cannot be predicted from the theory

Solution: The employer can always increase profits by removing the prejudice against black workers,

no matter if the adjustment takes place via employment (point c) or wage (point e). Correct answer is

b.

(j) How does the employment level of white worker is affected by discrimination against black workers?

(a) Employment of white workers goes up when the employer discriminates against black workers

(b) Employment of white workers goes down when the employer discriminates against black workers
Labour Economics (BSc) Academic year 2019-2020

(c) Employment of white workers is not affected by discrimination against black workers

(d) The employment response of white workers cannot be predicted

Solution: The optimal employment level for white workers is always determined by equating their MPL

with the prevailing wage. Hence, it is not affected by discrimination against black workers. Correct

answer is c.
Labour Economics (BSc) Academic year 2019-2020

Labour Economics Final Exam

Please do not turn over your sheet until all students have

received their exam, and you have been instructed to start.

You have 2 hours to complete the exam.

Good luck!