Final exam

Chapter 7 8 9 10
MC answer, short answers
Substitution effect, scale effect on different circumstances



Chapter 7 labor supply: household production, the family and life cycle
Categories of time allocation: -paid work, household work, leisure, personal care
Model for individual with household production:
Labor- leisure model
IC: downward slopinghousehold production could be replaced by purchased good or service


Income effect: Substitution effect:
increase income=increase household time increase wage rate=decrease household time
Implication: what does the slope of IC curve imply?

A: flat IC curve Explain: does not enjoy housework, not productive at housework, no kids or grown
up kids
B: steeper IC curve Explain: small children, enjoy or productive at housework

Joint labor supply decision
Unitary model: max U (Cf, Lf, Cm, Lm)
Collective model: max U ( Cf,Lf)+(bargaining power)*Um(Cm+Lm)
Bargaining power positive correlated with income
Specialization function: comparative advantage
Compare: - slope of IC curve - slope of BC
The joint decision: labor supply in recessions H, W
Added worker effect: productivity of H decrease at work
-comparative productivity of H at work decrease
-H increase household work
-W enters labor market
Discouraged worker effect: E(W)= probability of getting a job*W
Probability of getting a job decrease or wage decrease discourage workers from job searching
Added worker effect works in opposite direction of discourage worker effect
Dominant effect: Discouraged worker effect
1. Unemployment insurance welfare, benefit
2. More women already work regularly
3. Substitution effect is always greater for married women. As E(w) decrease, discourage
worker effect is larger
Life cycle aspect of labor supply:
Expected wage changeexpected life time income constant only substitution effect
Unexpected wage changeboth income and substitution effect
The choice of retirement age:
Time value of money

1. Cash flow of 10,000 starting now for 3 years
Time 1 2 3
Payment 10,000 10,000 10,000
Present value 10,000 + 10,000/1+i 10,000/(1+i)(1+i)
A= {[cash flow/ (1+i)^starting year-1]-[cash flow/ (1+i)^finish year-1]} / i

Case 1 Encourage early retirement:
-Increased early retirement benefit
-Decreased present value accumulated by late retirement


Case 2 encourage late retirement:
-Decrease early retirement benefit
- Increase present value accumulated by late retirement

Policy application: childcare
(A) Childcare subsidies
1. Decrease fixed costs of childcare=0

Budget Constrain without subsidies: ab+cd
Budget constrain with subsidies: abe
Case 1 increased household time, decrease working hour
Case 2 increased labor force participation
2. Reducing the hourly cost of childcare

Budget Constrain without subsidies: ab+cd
Budget constrain with subsidies: ab+cd
Both income and substitution effect
Effect: -increase labor participation rate
-for who worked for long hours without subsidy, income effect > substitution effect
decrease working hour
Child support assurance Goal: reduce absent parents
A) Children support assurance program: provide the custodial parent the money they need
B) Plus guarantees support payment

Effect: -very steep ICchose to stay at home
-people originally choose to work on BD income effectdecrease working hour
-choose not to work under child support assurance program with U1 enter labor market with U2
Conclusion: -increase labor supply - decrease working hour


Chapter 8 compensating wage differential and labor market
Pervious: Assume the non-monetary part of all jobs are same
This chapter: jobs are different
e.g. Nurse -Doctor -Freelancer -Investment banker
Holding everything else constant, job with unfavourable environment must paying more
compensating wage differentials
Assumption and prediction:
1. Utility maximization, Not max income
2. Worker information (worker knows features of jobs)
3. Perfect worker mobility in long run
Hedonic wage theory only consider risk as unpleasant factor
Convex indifference (utility) curve, higher utility if utility curve shifts to left
Employee side: Upward sloping indifference curve: people would be Indifference if higher risk is
compensated by higher wage
Convexity: change in wage will lead to a bigger change in risk when at lower risk level, but change in
wage will lead to a smaller change in risk when at higher risk level.
Steeper indifference curve: higher risk averse
Flatter Indifference curve: lower risk averse
Employer side: upward sloping Iso-profit curve, because it is costly to firm to reduce curve, in order
to keep same level of profit, firm needs to reduce wage
Higher profit curve, if profit curve shift to right
Concave: at lower risk level, if firm wants to reduce risk, they needs decrease wage more.
But at higher risk level, if firm wants to reduce risk, they just needs decrease less on wage.
Easier to decrease risk at higher risk level.
Flatter iso-profit curve could reduce risk more cheaply than steeper iso-profit curve.
Matching of employers and employees
Higher wage at low risk level VS. Higher wage at high risk level
Risk averse people choose the firm that could reduce risk more cheaply.
Offer curve: employer could afford + employee could potentially accepted

Insight of hedonic model:
-Wage increase with risk
-Job matching process firms and workers makes the most of their strength and preference.
Occupation safety and health regulation (OSHA)
Workers will not benefited by reduction of risk, because Job matching process, firms and worker
already made their decision.
If employee does not have perfect information about risk level, employee may believe their IC utility
above offer curve, but in reality their utility does not that high due to some health related symptom
will not appear in beginning.


If OSHA forces the risk level between R0 AND R2,
-cost: W1 - W
- Benefit: reduction of risk level
The most worker willing to pay: W1 W*
Worker willing to pay is more than the cost; Any wage between w to W* is Puerto optimal.
Because firm on the higher iso-profit curve and worker also on the higher utility curve.
Emperiricl study: If Cost greater willingness to pay greater and Cost to firm is much greater than
willingness to pay
Hedonic wage theory and employee benefit
Employee benefits: tax advantage
A) Payment in kind: e.g. insurance (health insurance is not taxable), commodities,
B) Deferred compensation: e.g. pension fund
Indifference curve of wage and benefit for employee: concave downward sloping
When employee have a higher level of wage, employee willing to give up more wage for smaller
amount of benefit.
But, when employee have a lower level of wage, employee willing to give up more benefit in order
to increase smaller amount wage.
When benefit is high, worker loss control of their wagewilling to give up more benefit to increase
wage.

Employer side
Employers preference only determined by the profits
Indifference curve for employer will be same as iso -cost curve, downward sloping straight line
Slope of iso cost curve
=-1: employers are indifference about paying wage or benefit
Flatter: employer prefer to pay benefit
Reason: -tax advantage - screening worker: deferred benefit attracts more future oriented worker
Steeper: employer prefer to pay wage
Reason: quasi-fixed cost:- too may part time worker, cost more than wage for par time employees
Determinant of wage and benefit: Care more about cash or care more about benefit

Appendix:
Unconstrained choice of work VS. Constrained choice of work
If hours of work is constraint to H at W*, utility decease
-employer have to offer W
-W-W* (compensating wage differential)
- Constrained choice of work is an unpleasant factor of working environment
Effect of uncertain layoffs
Job 1: wage W, hour is H
Job 2: wage W, hours H low with prob 0.5, H high with prob 0.5. 0.5*H low+ 0.5*H high=H


Weighted wage E = middle of straight line between C and D
Because of the job 1s utility curve is concave, but job 2s utility is straight line below the concave
curve, job 1 utility will always be higher than job 2.
Difference between utility of job 1 and job 2 shows there is exist compensating wage differential

Chapter 9 investment in human capital
If cost < benefit, invest in human capital
Cost:
A) Out-of-pocket expense: tuition, books
B) Psychic cost
C) Forgone earning
Benefit: benefit for every year, need to discount future value to present value
Benefit= B1/(1+R) + B2/(1+R)^2 + B3/(1+R)^3 + Bt/(1+R)^t
If cost < benefit, invest in education
Ways to compare Benefits and cost:
R is personal discount rate, rate of return not the interest rate
1) Specify R, compute cost and benefit
2) Set benefit=cost, compute R*
3) Large R education worth to investing
4) Forward looking more likely to invest in education, smaller discount rate more likely to
invest
Marginal cost: assume marginal cost is constant; high psychic cost high marginal cost
Marginal benefit: downward sloping, marginal benefit is decreasing when you spend one more year
on education, because people spent one more year on education means they will spent one year
less on work.
The demand for education

MC means higher psychic cost
MB means people with smaller increase in future benefit
Earning stream: A did not go to college, B with college education

The benefit of invest in education is deferred
Prediction from theory
1. Present-oriented people less likely to invest in education
2. Young people more likely to invest in education
3. Cost of education decrease college attendance increase
4. Wage gap larger college attendance increase
Empirical study:
1. Wage increased with the education
2. The most rapid earning occurs early(20-40), because concave earning age profile
3. Education-related earnings difference is greater in late year
4. Education-related earnings difference is greater for male
Concavity of earning age profile: on the job training


Over taking age: workers with the same level of education receive the same wage level, regardless of
whether they have invested in training
Corr (edu, wage) strangest at A*
The fanning out of Age / Earning profile:
Investment in on the job training is positively related
1) People who invest more in education: -low psychic cost, -smarter, -employers offers more
opportunity
2) People who invest more in education: -forward looking, -willing to invest in on-job training
Woman and acquisition of human capital
Less women choose to work full time:
- Employers less willing to invest in female
- Women are less likely to seek for training
Is education is a good investment to individual or social?
For individual, empirically return is 5 12 %
Problems:
1) Ability bias: overestimate the return. Smarter people tend to receive more education, smarter
people tend to earn more.
2) Selection bias: - psychic cost of schooling, -individual discount rate, smaller discount rate more
likely to invest in education
Social benefit: if education increase productivity, -positive externalitygood social investment
The signalling model: education does not increase productivity, serve as a tool to differentiate
peoples ability
If people with E* years of education has productivity 2,
If people with less than E* years of education has productivity 1
C
wage
B
2
D C/2
1 A
F
O Years of schooling
E*
Cost C: BD>OA Do not attend college
Cost C/2: BF (benefit from E* education) > OA (benefit from no education) attend college,
C
wage

2
C/2
1

O Years of schooling
E1 E2
E1 is more efficient than E2
In the range: education in order to differentiate people ability

Signalling or increase human capital
Current employer still emphasie on education:
- Employer believe education could improve productivity
- Or, Education is a less expensive tool to screen employees
Employers is willing to pay a high price for educated worker probably not purely signalling effect
School quality: there is a correlation between school quality and earning, but there is also problem,
such as ability bias and selection bias
Is public sector training a good social investment?
Empirical study show that public sector training only clearly benefit women.

Appendix: cobweb model



D0D1: - take time to adjust, - supply is N0, wage is W1, - if people are myopic, take W1 as new
equilibrium, - N0 N1, wage is W2, -
Assumption: assume what observed today is what will be observe tomorrow
Adaptive expectation: Wt= (t-1)/2 * At * Wt cause smaller fluctuation in prediction
Rational expectation:

Chapter 10 worker mobility: migration, immigration and turnover
The determinants of worker mobility:

Bt = benefit at new job (the increased utility in year t derived from changing jobs)
T = the length of time (in years) one expects to work at the new job
r = the rate of discount
C = the utility lost in the migration or moving itself (direct and psychic costs)
In this case, the summation of the yearly discounted net benefits over a period running from year 1
to year T
Geographic Mobility
The Direction of Migratory Flows:
Predict: From areas of relatively poor earnings possibilities places where opportunities are better.
The poorest area: people with low wealth, low education and low skills less like to move
The pull of good opportunities in the areas of destination > the push of poor opportunities in the
areas of origin.
People are more attracted to places where earnings are expected to be better, they do not
necessarily come from areas where opportunities are poorest.
Personal Characteristics of Movers:
Age: Age is the single most important factor in determining who migrates.
- Younger worker has longer working period (longer T)
- Younger worker have smaller psychic cost -e.g. personal network (smaller C)
Education: While age is probably the best predictor of who will move, education is the single best
indicator of who will move within an age group.
Whether ones occupation has local market, national market or international market
College graduate has national market and will be easy to find job in other country
Top university graduate has international market

The Role of Distance: longer distance, smaller likelihood to move
1. Moving cost increase with distance, e.g. flight cost, psychic cost
2. Trust worthy information decrease with distance
Worthy information from friends or relatives, knowing people in the company will easy get the job
The Earnings Distribution in Sending Countries and International Migration
Country A: compressed (equal) earning distribution Skilled and professional worker have larger
gain to migrate e.g. North European
Country B: less equal earning distribution unskilled worker have larger gain to migrate e.g. Mexico

Policy application: restricting Immigration
Naive view 1 : Illegal immigrant is going to take one job away from the local worker
Naive view 2: Illegal perform jobs that no local worker could do

Without immigrants: (W1, N1)
With immigrants: (W2, N2)
Job take away from local workers is N1-N3
Wage decreased is W1-W2

An analysis of gainer and losers
Consumer: wage decrease output price decrease consumer better off
Employers: profit increase from AW1B to AW2C employer better off
Skilled worker and unskilled workers:
Increase Immigrants - increase demand of good and service, - increase demand for worker, -
increase wage and increase employment any type of labor is complementary with unskilled labor
could expect to gain from unskilled immigrant


Unskilled worker: effect is ambiguous
Do the overall gain from immigration exceed the losses?
1. If immigrants work, Wage < marginal revenue of product (MRP) add value to country
2. If tax paid by immigrant > benefit received add value to country
Empirical study: tax from immigrants=benefit they receive
3. Unauthorized worker: -they mainly come for work, Wage <<MRP, -not eligible for welfare, -cannot
avoid tax payment (e.g. 75% of undocumented immigrants have their tax withheld)
Having undocumented immigrant is pareto-improving

Statement 1 could only be true with minimum wage
Minimum wage: -excess supply, - one job taken by illegals or legal immigrants, one less job could be
taken by local worker

Employee turnover
The mobility of employees among employers (also known as turnover or separations) can take
place without a change of residence
Wage effect: -lower wages higher quit rates; -wage increase turnover rate decrease
Effects of Employer Size: - quit rates tend to decline as firm size increases;
-turnover rate decrease with employer size, due to they pay higher wage and more internal
opportunities and promotion
Gender Differences: - female have higher quit rate; -female has lower wage and short career, if
we control the lower wage and shorter careers, females do not have higher turnover rate
Cyclical Effects: turnover rate highly correlated with economic condition high turnover rate in
good economy
Employer location: turnover rate increase with bigger size of the city and more job opportunities
International comparison: turnover rate is different between countries, because culture and
housing policies in Japan and Europe, employer provide housing subsidies

Is more job mobility better?
Positive: - create better job match; - create compensating wage differential
Negative: - reduce the incentive of on the job training