Prof

Prof. Bryan Caplan

bcaplan@gmu.edu

http://www3.gmu.edu/departments/economics/bcaplan

Econ 311

Fall, 1999

HW#2 (Please type all answers)

Write a table showing how many hours you would work per week at each of the following hourly real wages, assuming you will be able to earn no more than that real wage throughout your lifetime: $.10, $.50, $1, $3, $5, $10, $25, $50, $100. Graph your table.

Real Wage	Hours Supplied/ Week
$.10	100
$.50	90
$1	80
$3	60
$5	55
$10	50
$25	50
$50	50
$100	45

Repeat problem #1, assuming this wage is only available to you for a single day.

Real Wage	Hours Supplied/ Week
$.10	0
$.50	0
$1	0
$3	0
$5	0
$10	0
$25	50
$50	60
$100	70

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.

Show what happens to Aggregate Labor Demand and Aggregate Labor Supply if:

A plague kills half of all workers?

ALS falls - there are fewer people alive to work.

The government increases subsidies to (non-productive) education.

ALS falls - some people quit their jobs to become full-time students.

The government repeals a law against secretly monitoring workers with video cameras.

ALD increases - monitored workers goof off less, and thus produce more output. This increases workers' marginal product, so employers are willing to pay more for an hour of labor.

A new vitamin raises workers' IQs.

ALD increases - smarter workers are more productive and thus have a higher marginal product, so employers are willing to pay more for an hour of labor.

The courts rule that unions are immune to prosecution for acts of vandalism committed during strikes.

ALD falls - employers know that there is a greater chance that a worker will commit acts of destruction and thus on net actually have negative productivity. Thus, the expected productivity of a worker falls, so employers are willing to pay less for an hour of labor.

Higher taxes on gasoline make commuting more expensive.

ALS falls - people who are just on the margin of working or not worker decide to leave the work force. (I would also accept: ALS is unchanged: If ALS is vertical, indicating an insensitivity of work to the real wage, then it will also be insensitive to reductions in take-home pay in general).

Suppose there are two equal quantities of 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.

In France, unemployment is higher but real wages are lower than in the U.S. Draw Aggregate Labor Demand and Aggregate Labor Supply for both countries showing how this is possible.

Draw vertical labor supply curves for both countries. 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.

Provide a modernized example of one of the fallacies related to labor economics that Bastiat critiques. What would Bastiat say about it? (1 paragraph)

One popular view is that high-wage jobs are being eliminated by the computer, robots, and other new forms of technology. This is precisely the fallacy of Economic Sophisms' chapter 20, where Bastiat analyzes the fear that "mechanical labor" destroys the need for human labor. As Bastiat explains, though, when machines replace a laborer, this frees him to produce something else, and total production rises. The increase in production is what Bastiat calls "a gratuitous gift, a tribute that man's genius will have exacted from Nature." The labor saved does not disappear, but is merely "displaced" to a new task for which it is now better-suited.

Show what happens in the market for loanable funds if:

An earthquake hits Los Angeles.

Demand for loanable funds increases - the people who lost their homes and other possessions will "smooth their consumption" by borrowing more. (Optional: In addition, you could say that the supply of loanable funds decreases because lenders in LA will smooth their consumption by lending less).

People learn that the world will end in 2010.

Demand for loanable funds increases, and supply of loanable funds decreases. Everyone wants to borrow to enjoy the present, but few want to lend because they too would like to enjoy the present.

A new philosophy of patience sweeps the culture.

Demand for loanable funds decreases, and supply increases. Now few want to borrow, and many want to lend.

The government bans charging interest.

Neither curve shifts; rather, you should just draw a price ceiling at 0% interest, and show the resulting shortage of credit.

Draw a line representing your lifetime from birth to death. Shade the areas of the line where you expect to be a lender. Is this consistent with the permanent income hypothesis?

I expect to be a lender from age 26 to age 55, just as the permanent income hypothesis suggests.

Calculate your PDV of going to college, using your best guesses for your income if you do and don't go to college. (To save time, just do your calculations for 15 years after high school graduation). Assume the interest rate is 5%. Does college attendance have a positive PDV?

Here I calculate what my PDV was in 1989 (the year I started college).

Year	$Income	Present Value	Comment
1989	-20,000	-20,000	undergraduate - lost wages + tuition
1990	-20,000	-20,000/(1.05)	"
1991	-20,000	-20,000/(1.05)²	"
1992	-20,000	-20,000/(1.05)³	"
1993	-30,000	-30,000/(1.05)⁴	graduate school - no tuition, but higher opportunity cost
1994	-30,000	-30,000/(1.05)⁵	"
1995	-30,000	-30,000/(1.05)⁶	"
1996	-30,000	-30,000/(1.05)⁷	"
1997	+20,000	+20,000/(1.05)⁸	finish school, begin work
1998	+22,000	+25,000/(1.05)⁹	raises are higher than if I hadn't attended college
1999	+24,000	+30,000/(1.05)¹⁰	"
2000	+26,000	+35,000/(1.05)¹¹	"
2001	+28,000	+40,000/(1.05)¹²	"
2002	+30,000	+45,000/(1.05)¹³	"
2003	+32,000	+50,000/(1.05)¹⁴	"

Using a calculator, the PDV of the losses from 1989-1996 was -$166,359. The PDV of the gains from 1997-2003 was +$139,925. So the overall PDV=-$26,424. Perhaps college was a mistake for me? Of course, truncating the gains at 2003 makes the estimated benefit too low.

Using your answer to #11, guess what the interest rate would have to be to reverse your answer. (You're guess doesn't need to be right, but it must go in the right direction). Then calculate the PDV using the new interest rate. Was your guess too high? Too low?

Clearly, if the interest rate were lower, it would be more likely that college would pay. I guess that if the interest rate were 3%, the above table would have a positive sum. Punching in the numbers shows that the PDV of the losses from 1989-1996 was -$178,622, while the gain was $174,310, for an overall PDV=-$4312. I should have guessed a slightly lower interest rate, maybe 2.9%.

Comment on Caplan's argument that subsidies to education are a waste of money. State whether you agree or disagree, and explain your answer. (1 paragraph)

Unsurprisingly, I think Caplan's argument is compelling. While it is true that education increases individuals' income, it does not follow that if everyone gets more education, everyone earns more income. Most education does nothing to enhance job performance, and "learning how to learn" can take place on the job as well as in the classroom. Without subsidies, college would be unaffordable for many, probably a large majority of those who currently attend. However, college would also be unnecessary for most jobs that now require it. People would instead begin work earlier as apprentices and learn on the job.

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