Labour Economics: final exam

(S210009 S210030) a.y. 2015-2016

02.09.2016

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 on 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 employment rate.

Solution: The employment rate is the ratio between the number of employed per-
sons and the working age population, usually defined according the international
standards as people aged 15 to 64.

2. Define the marginal revenue deriving from the employment of one additional worker at
the firm.
S210009 S210030 Labour Economics 02.09.2016

Solution: The marginal revenue is the additional revenue obtained by the firm when
employing one additional worker. The marginal product of labour is the additional
output produced by the marginal additional worker, call it M PL . Let P be the
selling price of the output. Then, by employing one additional worker the firm
makes M PL × P , which is the marginal revenue.

3. What are the 4 properties of the indifference curves for a standard utility function.

Solution:

1. utility increases moving away from the origin;

2. indifference curves are negatively sloped;

3. indifference curves are negatively convex;

4. indifference curves are parallel to each other.

4. 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.
S210009 S210030 Labour Economics 02.09.2016

PART B. Long questions

1. Consider an individual with the following utility function over consumption (C) and
leisure (L):
U (C, L) = C 0.5 L0.5

Let p and w be the price of the consumption good and the wage rate, respectively. Let
T be the total endowment of leisure. Assume the individual has zero non-labour income.

(a) Derive analytically the equation for the indifference curves and the budget con-
straint in the C − L space and represent them graphically (You can draw only one
indifference curve as an example).

U2
Solution: The expression for the indifference curves is C = L
and its slope is
− CL . The expression for the budget constraint is C = − wp L + wp T and its slope
is − wp . Introduce graphs.

(b) Derive the individual optimal choice of consumption, leisure and labour with p = 2,
w = 4, and T = 100. Represent such optimal choice graphically.

Solution: Optimality is at the tangency of the indifference curves and the bud-
L
get constraint: C
= − wp = −2 ⇒ C = 2L. Replacing this into the budget
constraint yields L = 50 and consequently C = 100. The individual supplies
100 − 50 = 50 hours of work to the market.

(c) Assume now that the person receives a monetary gift of 40 from a relative. Derive
the new optimal choice of consumption, leisure and labour.

Solution: Now the budget constraint is pC + wL = wT + g, where g is the gift.

Following the same procedure of question b yields L = 55 and C = 110. Labour
supply is 100 − 55 = 45.
S210009 S210030 Labour Economics 02.09.2016

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

LD
A = 2800 − 6wA

LSA = 1500 + 19wA

and

LD
B = 1400 − 2wB

LSB = 1000 + 23wB

(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.

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

4200 − 8w∗ = 2500 + 42w∗

w∗ = 34

At this wage employment in the two sectors, by replacing in the labour demand
of sector, we obtain L∗A = 2596 and L∗B = 1332. Total employment is L∗ = 3928.

(b) How does the equilibrium of question (a) change if you assume that workers cannot
change sector?
S210009 S210030 Labour Economics 02.09.2016

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

2800 − 6w = 1500 + 19w

∗∗
wA = 52

L∗∗
A = 2488

Equating demand and supply in the B sector yields:

LD S
B = LB

1400 − 2w = 1000 + 23w

∗∗
wB = 16

L∗∗
B = 1368

Total employment is L∗∗ = 2488 + 1368 = 3856.

(c) Now, consider exclusively sector B and assume that this sector is unionized and that
unions and employers engage in efficient bargaining. Also, assume that the union’s
preferences over wages and employment are described by the following function:
U = 3L1/3 w1/3 . Compute the efficient bargaining equilibrium.

Solution: We now focus exclusively on the unionized sector B, so let us omit

the U subscript for notational simplicity. In the efficient bargaining model the
equilibrium is at the tangency of the union’s indifference curves and the labor
demand schedule. The labor demand curve in the w − L plane is 2w = 1400 − L
S210009 S210030 Labour Economics 02.09.2016

and it has a slope equal to −1/2. The slope of the union’s indifference curves is
(minus) the ratio of the marginal utility of employment and the marginal utility
of wages:

∂U w
= ( )1/3
∂L L
∂U L
= ( )1/3
∂w w
∂U ∂U w
/ = −
∂L ∂w L

Hence, the equilibrium condition is 2w = L. By replacing this into the demand

function we obtain the equilibrium level of employment:

2w = 1400 − 2w

w = 350

and the equilibrium labor is L = 700.

(d) Is there unemployment in the efficient bargaining equilibrium of question d? If yes,

how much?

Solution: At the equilibrium wage of 350, firms employ 700 workers but labour
supply is equal to Ls = 1000 + 23 × 350 = 9050, hence 9050 − 700 = 8350 units
of labour (workers) are unemployed.