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**office hours: 8:00AM – 8:50AM tuesdays LUMS C85**

ECON 102 Tutorial: Week 10 Ayesha Ali office hours: 8:00AM – 8:50AM tuesdays LUMS C85

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Question 1 H2OClean Ltd supplies domestic kitchen water filters to the retail market and hires workers to assemble the components. A water filter sells for £26, and H2OClean can buy the components for each filter for £1. Kevin and Sharon are two workers for H2OClean Ltd. Sharon can assemble 60 water filters per month, and Kevin can assemble 70. If the labour market is perfectly competitive, how much will each be paid? If the labor market is perfectly competitive, then each worker will receive a wage equal to their value of marginal product (VMP). So, to find the wage, we need to find the VMP for each worker. From lecture, we know that VMP is the net price of each unit sold. So, VMP = Marginal Product of labor (Market Price of the good – Cost to produce the good) Sharon’s marginal product is 60 air filters per month – that is the Marginal Product of her laobr, so her VMP = (60)(£26-£1) VMP = £1,500/month, so her wage will be £1,500/month. Kevin’s VMP is (70)(£26-£1) = £1,750/month. So his wage will be £1,750/month.

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Question 2(a) Stone Inc. owns a clothing factory, hiring workers in a competitive market to cut denim to make jeans. The fabric costs £5 per pair. The company’s weekly output varies with labour usage, as shown in the table below. Number of workers Jeans (pairs/week) 1 25 2 45 3 60 4 72 5 80 6 85 If the jeans sell for £35 a pair, and the competitive market wage is £250 per week, how many workers should Stone hire? How many pairs of jeans will the company produce each week?

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Question 2(a) Stone Inc. owns a clothing factory, hiring workers in a competitive market to cut denim to make jeans. The fabric costs £5 per pair. The company’s weekly output varies with labour usage, as shown in the table below. Number of workers Jeans (pairs/week) Marginal product of labour (pairs per worker) VMP (£/week) 1 25 2 45 3 60 4 72 5 80 6 85 Note: we might always find VMP = market wage, but basically what we want to do is keep adding additional workers as long as VMP>market wage. If VMP<market, then we do not want that many workers. If the jeans sell for £35 a pair, and the competitive market wage is £250 per week, how many workers should Stone hire? How many pairs of jeans will the company produce each week? To answer this, we want to find where is the VMP = the market wage. So, we need to find VMP. To find VMP, we need to first find out what the Marginal Product of labor is, so we’ll add a column for MP, and a column for VMP to our table above.

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Question 2(a) Stone Inc. owns a clothing factory, hiring workers in a competitive market to cut denim to make jeans. The fabric costs £5 per pair. The company’s weekly output varies with labour usage, as shown in the table below. If the jeans sell for £35 a pair, and the competitive market wage is £250 per week, how many workers should Stone hire? How many pairs of jeans will the company produce each week? After deducting the £5 cost of the fabric, the company received £30 from the sale of each pair of jeans. We can calculate the marginal product of labour and the value of the marginal product of labour are shown in the following table: Since the market wage is £250/week, it is not worthwhile to hire the fifth worker, whose VMP is only £240/week. The firm hires 4 workers and produces 72 pairs of jeans per week. Number of workers Jeans (pairs/week) Marginal product of labour (pairs per worker per week) VMP (£/week) = MP(P–C) 1 25 2 45 3 60 4 72 5 80 6 85 8 240 5 150

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Question 2(b) Suppose the Clothing Workers Union now sets a minimum acceptable wage of £230 per week. All the workers Stone hires belong to the union. How does the minimum wage affect Stone’s decision about how many workers to hire? A minimum wage (£230) that is below the equilibrium wage (£250) will have no effect on Stone’s decision. Number of workers Jeans (pairs/week) Marginal product of labour (pairs per worker per week) VMP (£/week) = MP(P–C) 1 25 2 45 3 60 4 72 5 80 6 85 8 240 5 150

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Question 2(c) If the minimum wage set by the union had been £400 per week, how would the minimum wage affect Stone’s decision about how many workers to hire? If the minimum wage is £400/week, the union wage is now higher than the equilibrium wage. Stone will no longer hire the fourth worker. Number of workers Jeans (pairs/week) Marginal product of labour (pairs per worker per week) VMP (£/week) = MP(P–C) 1 25 2 45 3 60 4 72 5 80 6 85 8 240 5 150

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Question 2(d) If Stone again faces a market wage of £250 per week but the price of jeans rises to £45, how many workers will the company now hire? If the market price of jeans rises to £45 a pair, the final column of the table now looks like this: If the equilibrium wage is £250/week, Stone will now hire a fifth worker. Number of workers Jeans (pairs/week) Marginal product of labour (pairs per worker per week) VMP (£/week) = MP(P–C) 1 25 2 45 3 60 4 72 5 80 6 85 8 320 5 200

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Question 3(a & b) Jones, who is currently unemployed, is a participant in three means-tested welfare programmes: food vouchers, rent vouchers and day care vouchers. Each programme grants him £150 per month in vouchers, which can be used like cash to purchase the good or service they cover. a) If benefits in each programme are reduced by 40 pence for each additional pound Jones earns in the labour market, how will Jones’ economic position change if he accepts a job paying £120 per week? Jones’s benefits will go down by (0.40)(£120/week) = £48/week in each programme. The total reduction of benefits is 3x£48 = £144/week. Another way we can think about this is, that if the benefits go down by .40 per £1 earned in wages, and if there are three programs, then actually, his total benefits are reduced by 3x(.40) per £1 earned, or they are reduced by £1.20 for each £1 he earns in wages. So, as long as his earnings are less than his benefits if he had no job, he is better off not working. b) In the light of your answer to part (a), explain why means testing for welfare recipients has undesirable effects on work incentives. When means-testing applied to multiple programmes results in effective marginal tax rates above 100 percent, as in this case, a person’s net income goes down as a result of earning money in the labour market. This creates a powerful incentive not to work. Questions 3-6 correspond with Week 9 Lecture Slides

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Question 4(a) Sue is offered a job re-shelving books in the University library from 12:00 to 13:00 each Friday. Her reservation wage for this task is £10 per hour. If the library director offers Sue £100 per hour, how much economic surplus will she enjoy as a result of accepting the job? When the £100/hour is paid directly to Sue, she accepts the job and enjoys an economic surplus of £100 - £10 = £90.

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Question 4(b) Sue is offered a job re-shelving books in the University library from 12:00 to 13:00 each Friday. Her reservation wage for this task is £10 per hour. Now suppose the library director announces that the earnings from the job will be divided equally among the 400 students who live in Sue’s residence. Will Sue still accept? If the £100 were divided equally among the 400 residents of Sur’s residence, however, each resident’s share would be only 25 pence. So, accepting the job would thus mean a negative surplus for Sue of £ £10 = -£9.75, so she will not accept the job.

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Question 4(c) Sue is offered a job re-shelving books in the University library from 12:00 to 13:00 each Friday. Her reservation wage for this task is £10 per hour. Explain how your answers to parts (a) and (b) illustrate one of the incentive problems inherent in income redistribution programmes. The income sharing arrangement is income redistribution of the most extreme form. Such measures reduce the amount of income available by reducing Sue’s incentive to accept employment that would have generated an economic surplus.

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Question 5 Using the concepts you’ve learned in Week 9 Lectures, can you explain why professional golfers earn more from endorsements than professional snooker players? Here is the suggested answer: The higher endorsement wage suggests that the value marginal product of a professional golfer is greater than that of a snooker player, i.e. the golfer is more valuable to the advertising firm than the snooker player. This reflects the much larger market size and fan base of golf (as measured by TV viewing figures): many more people play or, even more importantly, watch golf than snooker. So professional golfers are more famous than professional snooker players.

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Question 6 Suppose the demand and supply curves for unskilled labour are as shown in the graph below. By how much will the imposition of a minimum wage of £12 per hour reduce total economic surplus? Calculate the amounts by which employer surplus and worker surplus change as a result of the minimum wage. W 20 12 10 8 8, , , L S D Employer Surplus Worker Surplus Without a minimum wage, both employers and workers would enjoy economic surplus of £50,000 a day (= 0.5 x (£20 - £10) x (10,000)).

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Question 6 Suppose the demand and supply curves for unskilled labour are as shown in the graph below. By how much will the imposition of a minimum wage of £12 per hour reduce total economic surplus? Calculate the amounts by which employer surplus and worker surplus change as a result of the minimum wage. W 20 12 10 8 8, , , L S D Without a minimum wage, both employers and workers would enjoy economic surplus of £50,000 a day (= 0.5 x (£20 - £10) x (10,000)). With a minimum wage set at £12/hour, employer surplus is now 0.5 x (£20 - £12) x (8,000) = £32,000 a day, while worker surplus is now 0.5 x (£12 + (£12 - £8)) x 8,000 = £64,000 a day. The minimum wage thus reduces employer surplus by £18,000 a day, and increases worker surplus by £14,000 a day. The net reduction in surplus is the area of the shaded triangle, 0.5 x (£12 - £8) x 2,000= £4,000 a day.

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Question 6 Suppose the demand and supply curves for unskilled labour are as shown in the graph below. By how much will the imposition of a minimum wage of £12 per hour reduce total economic surplus? Calculate the amounts by which employer surplus and worker surplus change as a result of the minimum wage. Employer Surplus Worker Surplus Without a minimum wage, both employers and workers would enjoy economic surplus of £50,000 a day (= 0.5 x (£20 - £10) x (10,000)). With a minimum wage set at £12/hour, employer surplus is now 0.5 x (£20 - £12) x (8,000) = £32,000 a day, while worker surplus is now 0.5 x (£12 + (£12 - £8)) x 8,000 = £64,000 a day. The minimum wage thus reduces employer surplus by £18,000 a day, and increases worker surplus by £14,000 a day. The net reduction in surplus is the area of the shaded triangle, 0.5 x (£12 - £8) x 2,000= £4,000 a day.

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**Next Class Week 11 Worksheet Exam Revision (exam in week 12)**

There will be a sample test posted on Moodle. The exam will cover: Economics material from Week 6 onwards Math material on derivatives (Week 5 onwards?) Economics questions will be short answer, and there will be 7 math questions (4 marks each). Economics questions will likely involve you having to create or use diagrams, and payoff matrices and/or decision trees. You might also need to be able to solve problems algebraically. Have a nice holiday!

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