Labour Economics: final exam

(S210009 S210030) a.y. 2015-2016

13.01.2016

INSTRUCTIONS. The exam is in two parts. Section A includes 4 short questions and Section B

includes two longer questions. Students taking the 3-credit course should answer only the first two short

questions (A.1 and A.2) and the first long question (B.1). Students taking the 6-credit course should answer

all questions in both sections.

Use one separate paper sheet for each of the two sections (one sheet for the questions in part A and one

for the questions in part B) and clearly indicate your name and student number at the top of each sheet.

Students taking the 6-credit course have 2 hours to complete the exam. Students taking the 3-credit

course have 1 hour to complete the exam. You are allowed to use a calculator but notes, books and any

internet-connected devices are not allowed.

Good luck!

SECTION A. Short questions

1. Define the unemployment rate and explain briefly the internationally standardized pro-
cedure to compute it.

Solution: The unemployment rate is the ratio between the number of unemployed
persons and the labor force, that is the sum of the employed and the unemployed. The
ILO convention to compute unemployment rests on 3 key questions that normally
appear in labor force surveys. The first question asks whether the respondent was
employed during the reference week. Those answering yes are classified as employed.
Those answering no are asked the second question about whether they would be
available to start work immediately. Those answering no are classified as inactive.
Those answering yes are asked the third and final question about whether they have
S210009 S210030 Labour Economics 13.01.2016

actively looked for work in the reference week. Those answering no are also classified
as inactive and only those answering yes are coded as unemployed.

2. Explain briefly how Goldin and Olivetti (AER, 2013) measure the effect of WWII on
female labor supply. What effect do they find and who experienced it the most?

Solution: Using WWII mobilization rates as an instrument, Goldin and Olivetti

find that states with higher mobilization rates experienced an increase in female
labor supply (measured in terms of weeks worked and labor force participation).
The effect is concentrated on highly educated women.

3. Define the matching function and discuss its meaning.

Solution: The matching function is a relationship between the number of matches

(M ) formed in a given internal of time on the one hand and the number of unemployed
workers (U ) and the number of vacant jobs on the other (V ):

M = m(U, V )

It is usually assumed to be increasing and concave in both u and V . The matching

function captures the basic intuition of the search and matching approach that only
a certain number of unemployed workers will find a job in any given internal of time
whereas many other won find it due to the presence of a number of frictions.

4. Why do young people migrate more frequently than the elderly?

S210009 S210030 Labour Economics 13.01.2016

Solution: Because they have more time to enjoy the benefits of migration.

PART B. Long questions

1. Consider a perfectly competitive labor market with by the following labor demand (LD )
and labor supply (LS ):

LD = 50 − w
1
LS = 5 + w
3

where w is the market wage. Assume the selling price of the firms’ output is equal to 1.

(a) Compute the equilibrium wage and the equilibrium level of employment. Represent
the equilibrium graphically.

Solution: The equilibrium is at the intersection of labor demand and labor

supply:

LD = LS
1
50 − w∗ = 5 + w∗
3
w∗ = 33.75

Replacing this equilibrium wage into either the labor supply or the labor demand
equation yields L∗ = 16.25.

(b) Assume now that in order to stimulate employment the government offers to em-
ployers a subsidy of 5 for each employed person. Compute the new equilibrium and
represent it graphically.
S210009 S210030 Labour Economics 13.01.2016

Solution: Now the labor demand schedule becomes LD = 50 − (w − 5) and

consequently the new equilibrium wage is:

1
50 − w∗∗ + 5 = 5 + w∗∗
3
w∗∗ = 37.5

Employment is then equal to L∗∗ = 17.5. The government subsidy has been
successful at increasing employment from 16.25 to 17.5.

(c) Assume now that the subsidy is paid to the worker instead of the employer, namely
all employed people receive from the government a subsidy of 5 on top of their
salaries (and they don’t get the subsidy if they don’t work). Compute the equilib-
rium and represent it graphically.

Solution: Now it is the labor supply schedule that changes and becomes LS =
5 + 31 (w + 5) and consequently the new equilibrium wage is:

1
50 − w∗∗∗ = 5 + (w∗∗∗ + 5)
3
w∗∗∗ = 32.5

Employment is then equal to L∗∗∗ = 17.5.

(d) Compare the equilibrium in question (b) and in question (c) and discuss who benefits
from the subsidy.

Solution: The two equilibria feature the same level of employment but different
wages. However this simply reflects the identity of the formal beneficiary of the
subsidy. In question b the employer gets the subsidy so the cost of each employed
S210009 S210030 Labour Economics 13.01.2016

person is the wage minus the subsidy, namely 37.5 − 5 = 32.5. This is the same
cost of labor to the employer in question c, where the employer does not get the
subsidy and only pays the wage equal to 32.5.

Comparing with the original equilibrium in question a one can get a sense of
who really benefits from the subsidy. The employer pays 33.75 for each worker
in the absence of the subsidy and 32.5 when the subsidy is present, regardless
of who is the formal recipient. Hence, the employer gets 1.25 of the subsidy.
The workers get a take-home wage of 33.75 in the absence of the subsidy and
37.5 when the subsidy is present, hence they enjoy 3.75 of the subsidy. In other
words, two thirds of the subsidy go to the worker and one third to the employer.
This particular split is the result of the relative elasticities of labor demand and
labor supply.

2. Consider a labor market with two sectors, A and B. The schedule of labor supply and
labor demand in the two sectors are:

LD
A = 1400 − 3wA

LSA = 500 + 9wA

and

LD
B = 800 − 6wB

LSB = 500 + 14wB

(a) Compute the equilibrium wage and employment in the two sectors under perfect
competition and assuming that workers can freely move across the two sectors.
S210009 S210030 Labour Economics 13.01.2016

Solution: If workers can move freely across sectors they will keep doing so until
wages in the two sectors are equalized. Such equalized wage will be the wage at
which total demand equals total supply:

LD D S S
A + LB = LA + LB

2200 − 9w∗ = 1000 + 23w∗

w∗ = 37.5

At this wage employment in the two sectors is L∗A = 1287.5 and L∗B = 575. Total
employment is L∗ = 1862.5.

(b) How does the equilibrium of question (a) change if you assume that workers cannot
change sector?

Solution: If workers cannot move across sectors then the equilibrium is just
the standard perfectly competitive equilibrium derived separately in the two
markets. Equating demand and supply in sector A yields:

LD S
A = LA

1400 − 3w = 500 + 9w
∗∗
wA = 75

L∗∗
A = 1175
S210009 S210030 Labour Economics 13.01.2016

Equating demand and supply in the B sector yields:

LD S
B = LB

800 − 6w = 500 + 14w

∗∗
wB = 15

L∗∗
B = 710

Total employment is L∗∗ = 1175 + 710 = 1885.

(c) How does the equilibrium of question (b) change if you abandon the assumption of
perfect mobility across sectors and introduce a fixed cost of moving equal to 4.

Solution: Given the wage differences derived in question b, workers will want
to move from sector B to sector A and they will do so until the wage in sector B
is equal to the wage in sector A minus the cost of moving. Hence one additional
equilibrium condition is wB = wA −4. The equilibrium wage can then be derived
solving the following condition:

LdA (wA ) + LdB (wA − 4) = LsA (wA ) + LsB (wA − 4)

1400 − 3wa + 800 − 6(wa − 4) = 500 + 9wA + 500 + 14(wa − 4)

wA = 40

wB = 40 − 4 = 36

Given these wages, employment in sector A will be LdA = 1400 − 3 × 40 = 1280

and employment in sector B will be LdB = 800 − 6 × 36 = 584. At the wage
wA = 40 labor supply in sector A is LsA = 500 + 9 × 40 = 860 so there is excess
demand of 1280 − 860 = 420. Hence, 420 workers will move from sector B to
S210009 S210030 Labour Economics 13.01.2016

sector A. Labor supply in sector B then is LsB = 500 + 14 × 36 − 420 = 584,

which corresponds to labor demand in the same sector.

(d) Start from the equilibrium derived in question (b) and maintain the assumption of
no mobility across sectors. Assume that in sector A now operates a monopolistic
union imposing a wage of 85. Compute the new equilibrium wage and employment
in both sectors and indicate if there is unemployment in either sector A or B.

Solution: The equilibrium in the B sector is the same as in question b whereas

in the A sector there will be excess supply. In fact, at the union wage of 85
employers are willing to hire LdA = 1400 − 3 × 85 = 1145 and labor supply is
LsA = 500 + 9 × 85 = 1265, hence equilibrium employment will be 1145 and
1265-1145=120 workers will be unemployed.