Consider the labor demand schedule table


Directions: Answer all of the following questions on your own paper and turn them in at the start of class on Thursday, Sept. 22nd. You may discuss the questions with your classmates. However, you must turn in your own set of answers that reflect your own work.

1. Mary has two possible career paths. She can become either a biologist or a concert pianist. Mary lives for 2 periods. In the first period she gets the appropriate education for her career. In the second period, she works in the labor market. If Mary becomes a biologist, she will spend $15,000 on education in the first period and earn $475,000 in the second period. If she becomes a concert pianist, she will spend $38,000 on education in the first period and then she will earn $500,000 in the second period.

(a) Suppose Mary can lend and borrow money at a market interest rate of 10 percent between the two periods. Which career will she pursue? Briefly explain your answer.

(b) Suppose the market interest rate falls to 2 percent. Would Mary choose a different career path than in (a)? Briefly explain why this is the case.

2. From the late 1970's through 2000, the college wage premium increased rapidly. At the same time, the supply of college graduates to the labor market increased relative to the supply of high school graduates. What do these trends imply about the demand for college relative to high school graduates in the U.S. labor market over the time period? Clearly state the implica¬tions, and illustrate the changes using a graph of supply and demand that relates the college wage premium and the ratio of college to high school graduates. Briefly discuss one underlying cause for these observed trends in the U.S. labor market.

3. Suppose there are two types of persons: high-ability and low-ability. The schooling required to obtain a particular diploma costs a high-ability person $8,000 per year, and it costs a low-ability person $10,001 per year. Firms wish to use this diploma as a signal of an individual's ability. The firms intend to pay workers such that the present value of lifetime earnings for a worker without the diploma is $250,000 and the present value of lifetime earnings for a worker with the diploma is $450,000.

(a) What range of years of education must be required to obtain this diploma in order for the diploma to be an effective signal of worker ability?

(b) In a competitive labor market, how many years of education will be required to obtain this diploma in equilibrium? Briefly explain why this is the case.

4. Suppose a firm in a competitive industry faces an equilibrium product price of $2 per unit of output. Table A provides information on the output produced by various amounts of labor. Use this information to complete the remaining columns of Table A, and to fill in the labor demand schedule in Table B.

Units of Labor

Total Product             AP                              MP                                     MRP















Table B: Labor Demand Schedule


Wage Rate 24

16 8

Quantity Demanded


(a) Complete Table A, where AP is the average product of labor, MP is the marginal product of labor, MRP is marginal revenue produce of labor.

(b) Briefly explain why the marginal revenue produce of labor (MRP) will be equal to the value of the marginal product of labor (V MP) in this market.

(c) Complete Table B, with the labor demand schedule for this firm at different wage rates.

(d) If the equilibrium market wage rate is $8, what is the equilibrium quantity of labor hired by this firm?

5. Consider the labor demand schedule in Question 4 above.

(a) Use the total wage bill rules to determine whether labor demand is elastic or inelastic over the $16 to $8 range.

(b) Use the midpoint method to compute the elasticity coefficient of labor demand over the range from $16 to $8.

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