Economics 321 Midterm

Prof. Bryan Caplan

Fall, 2005


Part 1: True, False, and Explain

(10 points each - 2 for the right answer, and 8 for the explanation)

State whether each of the following six propositions is true or false.  In 2-3 sentences, explain why.  Use diagrams if helpful.


1.  Suppose workers dislike coffee, but it makes them more productive by helping them to wake up in the morning.


T, F, and Explain:  If the Aggregate Labor Supply curve is backwards-bending, free employer-provided coffee will still increase workers' average wages throughout the economy.


TRUE.  ALD increases due to increased productivity, and ALS shifts back due to the greater unpleasantness of work.  Both result in higher wages.  In fact, the wage shift is greater than it would be with a vertical or forward-sloping ALS curve.











2.  Is a 2 percent wage increase in the face of 5 percent inflation the same thing as a 3 percent wage fall in the face of stable prices?  To hyperrational workers, it might be; but common sense suggests that in practice there is a big psychological difference... (Paul Krugman, The Accidental Theorist)


T, F, and Explain:  According to Krugman, inflation is always an effective tool for reducing unemployment due to nominal wage rigidity.


FALSE.  Krugman only argues that inflation reduces unemployment under some conditions, particularly when inflation is very low.  He clearly admits that "There is overwhelming evidence... that 10 percent inflation does not buy a long-term unemployment rate significantly lower than that which can be sustained with 5 percent inflation." (pp.118-9)







3.  Suppose all U.S.-born workers are skilled, and all immigrants are unskilled.


T, F, and Explain:  Allowing more immigration helps U.S. employers, but hurts U.S.-born workers.


FALSE.  As explained in the notes, (1) Immigration of people with different skills than natives increases production via comparative advantage, and (2) Natives with the same skills as immigrants suffer lower wages, but natives with different skills will see their wages go up.  Since by assumption none of the native workers have the same skills as the immigrants, U.S. employers AND U.S.-born workers are better-off.


4.  "OSHA might, therefore, simply raise the level of occupational safety and health to the level at which it would be" [under laissez-faire].  (Posner, Economic Analysis of Law)   

T, F, and Explain: Posner blames pro-union laws for reducing the level of worker safety.

FALSE.  As Posner explains on pp.364-5, his point is that "the public subsidy of workers' injuries and illnesses" encourages workers to buy less safety from their employers.  Perhaps, he argues, OSHA simply counteracts workers' tendency to take fewer precautions because government pays for much of the expense of their accidents.


5.  Suppose people could not begin collecting Social Security benefits until they turned 80.


T, F, and Explain:  According to human capital theory, people would now want to get more years of education.


TRUE.  If you work for more years, education adds to your wages for a longer time period.  The PDV of education therefore goes up.  Since the benefits are far in the future, it won't be a large effect, but it would still be enough to change the minds of the marginal student.


6.  “Cultural bias” is the most popular complaint about intelligence tests.


T, F, and Explain:  This complaint is meaningless because there is no way to empirically determine whether or not a test is culturally biased.


FALSE.  This complaint is meaningful, but false; a meaningless complaint is by definition impossible to test because it doesn't really say anything.  A test is culturally biased if it underpredicts the practical performance of groups that score low.  For example, if you use intelligence tests to predict the ability to drive a tank through an obstacle course, it would be evidence of cultural bias if members of groups that performed poorly had better performance than you would predict from their test scores.  In fact, groups that do poorly on intelligence tests seem to perform even worse than their scores would predict.






Part 2: Short Answer

(20 points each)

In 4-6 sentences, answer both of the following questions.  Use diagrams if helpful.



1.  Historians often argue that since the unemployment rate during World War II was extremely low, labor demand must have been much higher than it was today.  But economists point out that real wages are MUCH higher today than they were during World War II.  Use Aggregate Labor Demand and Aggregate Labor Supply curves to resolve this dispute.  Hint: During World War II, regulations often set maximum wages.


The economists are right, and the historians are wrong.  The easiest way to understand labor markets in WWII versus today is to draw two ALD-ALS diagrams.  During WWII, ALD was much lower than today, but there was a maximum wage below the intersection of S&D, leading to a labor shortage/low unemployment.  Today, ALD is much higher, but there is a minimum wage and other labor market regulations that push wages above the intersection of S&D, leading to a labor surplus/high unemployment.











2.  Suppose that slavery had never been legally abolished in the 19th-century.  Assuming that worker productivity would have continued to rise, would market forces have abolished slavery by now?  Explain your reasoning.


As explained in the notes, slave-owners will want to free their slaves once demand is so low than the price of slaves falls to zero.  Demand for slaves depends on MVP – cost of subsistence  - cost of enforcement.  MVP clearly increased since the 1860's – the least-skilled worker today lives live a king compared to 150 years ago.  Subsistence is cheaper than it used to be, because modernization has drastically cut the cost of food and other necessities.  It is hard to tell if enforcement costs have gone up or down; better technology like house-arrest anklets makes it easier to monitor others, but transportations costs are much lower, making it easier to escape.  On balance, then, it looks like the demand for slaves would have gone up, not down, and slavery would be alive and well today.


The best counter-argument to this line of reasoning is that slaves' MVP would have risen EVEN MORE in occupations where enforcement is costly – especially highly skilled occupations.   Slave-owners would initially respond to this change by giving their slaves independence in exchange for a share of their wages.  Once this became common, however, slaves would be willing and able to buy their freedom.  After a few generations, this might eliminate slavery.