ECON 3240.03A Final Examination

York University

Final Examination

Course Director: S.H. Chiang

Course number: ECON 3240.03A

I.

1. Why do those who argue that more education signals greater ability believe that the most able people will obtain the most edcuation? Provide a theory to justify this. [[[Ans: The question can be answered by referring to the theory of signaling in chapter 9, p.9-15 of the lecture note (for details, see textbook). Given that the costs of education for types 1 and 2 are different, the employer is able to force workers with different qualities to choose different education levels by setting a standard y∗ at the proper level. Low-quality workers are better off by having no education, while high-quality workers find it beneficial by choosing the required education level y∗. The pays to low and high-quality workers $1 and $2, respectively. Clearly, people with greater ability would have higher level of education. ]]]]

2. In many countries education is heavily subsidized by the government and is practically free. Given this, is the belief in (1) justifiable? Explain. (18 points) [[[Ans: Yes. The costs of education include not only money costs but also psychic costs. Subsidies from the government does not invalidate the assumption that costs differ among individuals with different talents. This still leaves the employers with some room to manipulate the standard to produce a desirable outcome described in (1).]]]

II. Answer two related quesitons:

1. In the traditional model of migration, migration decisions depend on age, discount rates, earning differentials, and costs. Explain. (10) [[[Ans: Refer to the theory in chapter 9, pp.9.5-9.10. As shown, individuals are more likely to go to the college if they are younger, discount rates are lower, earning differentials are greater, and costs are smaller. ]]]

2. The new approach attributes asymmetric information as an underlying reason for migration. Consider some potential migrants who are currently in the host country. Firms in the host country are assumed to have perfect information about individuals’ productivities and can therefore pay them according to their productivities. Nevertheless, firms in the home country cannot observe their productivities and therefore have no choice but to pay all returning workers a uniform wage. Who are likely to migrate in this case? Explain. (20 points) [[[Ans: For details, see “An economic model of brain drain” by Kwok and Leland (the article is posted on the course website (supplementary material for chapter 11). The inferior workers are more likely to move back to their home country. This is because the firms in the home country pay all returning workers the uniform wage and low-quality workers can free ride workers with better quality. However, high-quality workers are better off in staying. Otherwise, they will end up subsidizing inferior workers.]]]

III. Answer:

1. Use the monopoly union model to examine the effects of attractive EI payments on union wages and employment. [[[Ans: see chapter 11, pp.15.8-15.9 (lecture note). The union wage and employment are determined by the tangent point between the union’s utility function and the demand for labor function.]]]

2. A left-wing government intends to introduce a law that makes temporary layoffs and dismissals on short notice illegal. Under the law, a dismissal is illegal if it is socially unjustified, and it is considered socially unjustified if the worker could be employed in a different position or establishment of the firm, even one requiring retraining. Workers illegally dismissed may sue their employers. What are the likely effects of this law on union wages and employment in the short and long run. (20 points) [[[Ans: This makes the demand for union labour inelastic. It is then feasible for the union to exploit monopoly power. Other things being equal, one would expect that union wages are higher. Consequently, the level employment is marginally low because of inelastic demand for labor. In the long run, the demand for union labour falls because out-sourcing begins to take place or firms may eventually decide to move to a place with less restriction.]]]]

IV. Short Questions: (42 points; 7 per question)

1. Explain why labour turnovers are often lower for people with firm-specific skills. [[[Ans: For firm-specific human capital investment, costs are shared and benfits are also shared between the workers and the employer. For workers, they are likely to quit since they wish to get back their investment. For firms, they pay part of the traning costs and therefore they have every intention to keep the workers as well. In short, the employment relationship is more stable if workers are equipped with firm specific skills. To illustrate your answer fully, the graph in chapter 11, p.9.19 (lecture note) should be used.]]]

2. The baseball skills are purely general. Yet, the major league teams pay the costs of training. Major league baseball teams scout and hire young players who they then train in the minor leagues for a period of three to five years. Very few of their trainees actually make it to the major leagues, but if they do they are bound to the team that owns their contracts for a period of 6 years. After that, the player can become a “free agent” and choose any major leagues team to play. Is this inconsistent with the human capital theory? Why? [[[Ans: For general human capital, the trainees should bear the full cost of training. However, the restriction imposed on players impairs players’ ability to move. Employer’s investment is therefore fully protected. Paying the costs by the employer is not inconsistent with the theory. To answer this question, you should first explain the theory by referring to the material on chapter 9, pp.9.17-9.18 (lecture note) and then make a connection between the theory and the restriction mentioned in the question.]]]

3. Consider an isolated small town in which all residents are the employees of Company X. Describe how the equilibrium wage and employment are determined there. What effect does the minimum wage have on employment and wage? [[[Ans: For details, look at chapter 7 (monopsony section and pp.7.26-7.28). If the minimum wage is not too high, it will have on positive effect on employment. However, if the minimum wage is set too high, then it will have an adverse effect on employment. ]]]

4. Show how both union workers and the firm potentially could be better off by agreeing to wage and employment combinations that are not on the demand for labour function. [[[Ans: See chapter 15, pp.15.12-15.15. The efficient bargaining will result in a solution on the contract curve. Apparently, the contract curve is above the demand for labor function, thus proving the claim.]]]

5. The full-time faculty members at York are often given the preference over the part-time faculty members to teach the summer courses. Yet, the rate at which the unversity pays to its full-time faculty members per summer course is 1000 dollars less than what it would normally pay to the part-timers. Can you think of any economic rationale that justifies this phenomenon. [[[Ans: Risk (or uncertainty) and wage carry a positive relationship (see chapter 8, pp.8.3-8.18). The university does not guarantee the part-time faculty members with a course to teach. They therefore face greater uncertainty. Their rates reflect the uncertainty they face. That is, their rates carry risk premiums and are naturally higher.]]]

6. It is observed that in the nonunion chemical industries as well as in such industries as soap making, the most dangerous jobs were handled by the lowest-paid, less-educated, and usually minority worker. Does that suggest that compensating wage differentials in the non-union sector do not exist? Why or why not? [[[Ans: No, it certainly does not imply that the theory of compensating differentials is wrong in this case. Obviously, as risk increases, according to the theory of compensating differentials, we would expect wages to increase. However, many other factors, such as the structure of the labour market or the structure of the product market, can also influence wages paid. For example, the skill levels for less-educated workers tend to be lower and the supply is plenty. This leads them to make less, although the tradeoff between risk and wage remain to exist.]]]