Econ 190 / September 29, 2003
Definitions (3 points each):
1. Labor Force Participation Rate:
2. Reservation Wage:
3. Unemployment Rate:
4. Intertemporal Substitution Hypothesis
Short Answer/Applications (38 total points):
1. (7 points) An economist interested in studying the elasticity of labor supply among prime age men might run the following regression:
______
Describe what the signs on the coefficients tell us about the income and substitution effects. Can we determine unambiguously what the signs on the coefficients must be from a theoretical standpoint? Be explicit in your variable definitions (in other words, if you define wages as “w,” be sure to indicate that).
2. (3 points) Two workers who both choose to supply 40 hours each week to the labor market have very different indifference curves. If one worker has steep indifference curves, while the other worker’s are relatively flat, what can you determine about the wages each receives? Who earns a higher hourly wage? Why?
3. (2 points) Mathematically, the optimization of a worker’s labor supply choice implies: Interpret this condition.
4. (3 points) Suppose Jeff experiences an increase in wages from below his reservation wage to above his reservation wage.
a. What can you conclude about the income and/or substitution effect(s)? Do they both exist? If so, which one will dominate?
b. The slope of the budget line for his reservation wage is exactly equal to ______(note: this answer is theoretical, not numerical).
5. (5 points) Describe and explain the shape of the age-hours profile for a typical worker. In other words, what does it look like and why?
6. (6 points) Suppose the government grants $2500 per child to households that have two or more children. Do these child allowances influence the fertility behavior of households that had no children prior to the government program? Graph and explain. You may assume for simplicity that initially V = 0.
XN
7. (12 points) The current administration has supported the use of tax cuts for workers and firms in an effort to stimulate the economy. Consider the effects on labor supply of the following two tax cut options aimed at benefiting workers.
Use graphs to illustrate: i) the worker’s original budget constraint assuming V > 0 (indicate the slope), ii) the new budget constraint with the new tax plan in effect (indicate the slope), and iii) a decomposition of the income and substitution effects if they both exist. Be sure to also describe which of the income and/or substitution effects exist (and why) and how hours of work will change for different workers, if it can be determined unambiguously.
a. An increase in the fixed component of taxes; for instance, much like what was done in 2001, suppose all workers received a lump sum $300 tax refund.
C(a) L
b. A decrease in the income tax rate; in other words, suppose wages were originally taxed 15% and are now 13% of a worker’s earnings.
C(b) L
HONOR CODE PLEDGE: I affirm that I have neither given nor received aid on this exam. ______