Prof. Bryan Caplan

Econ 103

Spring, 2000


HW#4 Answer Key


Gwartney and Stroup:


Chapter 9

Critical Analysis: 3, 9, 10, 12 (2-3 sentences)


3.  Educational requirements shift the supply curve for engineers, doctors, and lawyers back, which raises wages.  But this is probably not a complete explanation for their high wages.  In all likelihood, people who become engineers, doctors, and lawyers would have been highly productive works even without education.  This means higher demand for their services (due to higher marginal productivity), and even lower supply in individual occupations (due to good options in other occupations).


9. a.  Both lawyers and ministers need a lot of schooling and strong verbal abilities.  The main differences are probably much lower demand for ministers, plus the pleasantness or "fun" of the two jobs.  Demand for ministers are lower, and there are a lot of people willing to take low pay in order to be ministers.


b.  Both accountants and elementary school teachers have similar educational requirements.  So again, the main differences are probably "fun" (more people like teaching), and demand (people are willing to pay more for accountants).


c.  Business executives and social workers differ in many respects: business executives probably require more schooling, have less pleasant ("high stress") jobs, and are doing something much more productive in terms of monetary value.


d.  Country lawyers and Wall St. lawyers may seem to have the same educational requirements, but normally the Wall St. lawyers go to much more selective law schools which admit only very high-ability students.  Also, Wall St. lawyers have a lot more stress.


e.  The main differences between an experience, skilled craftsperson and a 20-year-old high school drop-out are pretty obvious: experience, skill, and educational requirements are all greater for the craftsperson.


f.  The upper-story window washer accepts more risk (if he falls, he dies) than the ground-floor washer.


10.  False.  Even then, jobs that are more widely seen as "fun" would pay less.  Similarly, more risky jobs would pay more.


12.  a.  Reduces supply (the night shift is more unpleasant), and thus raises wages.

b.  Assuming workers get paid for the "off" hours, wages fall.  Lower productivity reduces demand, and more "off" time (assuming "off" time is more fun than real work) increases supply.

c.  Increases supply (higher non-wage compensation), reduces wages.

d.  Increases supply (more "fun" to have prestige), reduces wages.

e.  Reduces supply (having to move around a lot is unpleasant), and thus raises wages.

f.  Reduces supply (having to travel a lot is unpleasant), and thus raises wages.


Additional Required Problems


Use supply and demand curves to analyze the following questions.  In 1-2 sentences, explain your answer.


1.  Recall that housing supply is very inelastic while housing demand is fairly elastic. 


a.  What happens to the Reston housing market when the Metro announces plans for a Reston Metro stop?


Demand for housing increases, since it becomes more convenient to commute from D.C. to Reston.  Price sharply increases, quantity rises only slightly.








b.  What happens to the San Francisco housing market when there is a large nation-wide increase in the demand for computer programmers?  (There are a lot of programmers and computer firms in the SF area).


Demand for housing increases because as computer programmers get richer, they want more high-quality, good-location real estate.  Price sharply increases, quantity rises only slightly.









c.  Suppose SF has tough rent control laws.  How would your answer to (c) change?  How would it stay the same?


The price would not rise; instead, existing housing shortages would get much worse.








2.  Recall that both demand for credit and supply of credit are fairly elastic.


a.  Currently most state laws refuse to enforce credit contracts for minors (people under 18).  What does this do to the market for loans to kids?


Supply sharply decreases, since the probability of repayment is much smaller when there are no legal penalties for default.  At the same time, demand increases.  With unregulated interest rates, kids would just have to borrow at very high rates.










b.  How would your answer to (b) change if there were usury laws as well?


Kids would face a massive shortage of credit: the equilibrium interest rate would be way above the usurious (maximum) rate.








Additional Problems


1.  By working an extra hour, a farmer can produce 3 additional bushels of wheat.  If wheat sells for $10/bushel, what is the farmer's marginal product?  What happens to his marginal product if he gets stronger?  If the price of wheat falls?


The marginal product of an hour's labor is 3 bushels*$10/bushel=$30.  If he gets stronger, his marginal product increases; if the price of wheat falls, his marginal product falls.


2.  Suppose there are equal quantities of two kinds of labor: skilled and unskilled.  Demand for skilled labor is much higher: the market wage of skilled workers is $20, the market wage of unskilled is $3.  Diagram the effect of a $7 minimum wage on both markets.


There is no effect in the market for skilled workers: wages and employment stay unchanged, and there is no surplus of labor.  In the market for unskilled workers, wages rise to $7, employment falls, and there is a surplus of labor.


(Particularly clever answers would also show demand for skilled workers increasing, as employers, facing a higher price of unskilled labor, substitute skilled labor for unskilled.


3.  In France, unemployment is higher but real wages are lower than in the U.S.  How is this possible?


Draw labor supply curves for both countries.  They should probably be almost vertical - few people are going to leave the U.S. or France just because wages are low.  Draw labor demand in the U.S. as greater than in France, reflecting the higher marginal productivity of U.S. workers.  Finally, draw a minimum wage for France that exceeds the equilibrium French real wage, but is less than the equilibrium U.S. real wage.  The U.S. labor market can either be shown without a minimum wage, or with a minimum wage only slightly above the equilibrium level.


4.  Why are meals at McDonald's (a low-quality restaurant) cheaper than at the Red Lobster (a higher-quality restaurant)?


Two reasons: McDonald's means cost less to produce, which increases supply curve; and people like McDonald's meals less, which reduces demand.  Both forces push prices down.


5.  Suppose the laws against sale of marijuana are weakened (for example, by paroling drug-dealers after only 3 years), while laws against use of marijuana are strengthened (for example, by imposing a 3-year mandatory minimum sentence for use).  What happens to the market for marijuana?


Supply increases while demand decreases.  The effect on quantity is ambiguous, but price definitely falls.


6.  How much time do you spending "searching for" (selecting) your classes?  Have you ever found yourself stuck in a bad class because you did not search enough?


I usually spent about 90 minutes selecting classes; I also dropped ones that seemed particularly bad during the first week.  Only rarely did I ask other students about professors' reputations.  As a result, I did have a couple of really awful classes.


7.  Why do insurance policies with deductibles cost less?  Give two reasons.


The actuarially fair premium is just the product of the payout if an accident occurs times the probability of an accident.  Policies with deductibles by definition have lower payouts given an accident.  But when there are deductibles, accidents are also less likely to happen in the first place because people have an incentive to avoid them.


8. a.  Which class in college has given you the most job-related skills? 


Graduate Microeconomics.


b.  Which class in college has given you the least job-related skills? 


Ancient Philosophy


c.  What percent of the first class was "signaling" (as opposed to job-related training)?  What percent of the second class was "signaling"?


20%; 100%.