Problem Set 4 Answer Key

1. Your answers should focus on differences in human capital (skills and education), discrimination, and differences in degree in degree of household specialization, and differences in job types, among other things.

2. Restrict imports, support minimum wage laws, advocate consumers to buy union made products, raise the MP of union members.

3. Any wage over the equilibrium wage of $8 will cause an excess supply of workers--in other words, unemployment. By raising the wage to $12 per hour, the union is essentially trading off some jobs for the higher wages.

4. Immigration into the US will tend to lower US wages (due to higher labor supply here) and raise wages in other countries (due to lower labor supply there). However, the effect on US wages is not large because there are offsetting effects. Immigrants may also increase the demand for labor because they buy goods and services here also. Second, immigrants bring capital with them, which makes US workers more productive. Third, immigrants may be a complement rather than a substitute for high skilled US labor.

5. I'll leave this one for you to work through.

6. Becker argues that since prejudiced based discrimination is costly to businesses, businesses that do discriminate will eventually lose market share to those that don't discriminate.

7. This one is straight out of your notes.

8. High school English and math teachers.
a) Yes. The shortage of math teachers would suggest that their salaries are too low relative to English teacher salaries.
b) The shortage of math teachers could be "solved" by lowering the employment standards for hiring math teachers. The surplus of English teachers could be "solved" by raising the standards for hiring English teachers.

9. I'll leave this one for you to ponder.

10. Rational ignorance suggests that people will not spend a lot of time and money worrying about every piece of legislation debated by governments. Special interest groups, however, will attempt to manipulate the political process to their advantage in order to secure concentrated benefits at taxpayer expense.

11. Mosquito abatement program.
a) Under majority rule, only Charlie would vote in favor of the abatement program (since he values the program at $100, which is more than the cost to each owner of $35). Thus, the abatement program would not be approved. From society's point-of-view this would be inefficient since the total value of the program to the three guys ($120) is greater than the total cost ($105).
b) Unanimity could be reached by having Charlie subsidize Art and Bob's "tax bill." Assuming Art and Bob are willing to pay their values, Charlie could pay $34 on behalf of Art and $16 on behalf of Bob in order to pay for the abatement program. All parties would thus benefit.

12. The class in which students earn their own grades will have the higher class average. The class in which students earn the class average as their grade will attract a lot of free riders. The free riders are likely to be (how should I say) academically-challenged, thereby ensuring an overall lower class average.

13. I'll leave this one for you to ponder.

14. Private costs = $10,000
External costs = $5000 + 4000 + 1000 = $10,000
Social costs = private + external = $20,000

15. On the one hand, a monopolist is inefficient because it tends to underproduce. On the other hand, a firm that generates a negative externality tends to overproduce its product. Combining these two yields an uncertain outcome since the two effects may tend to offset each other to some degree.

16. We talked about this one in class.

17. Fishermen and sludge.
a) The fishermen will buy the nets at a cost of $2750.
b) The factory will buy the nets for the fishermen at a cost of $2750.
c) The tax is likely to be set equal to the damage done by the sludge to the fishermen, namely, $4000. Given this potential tax liability, the factory will try to minimize its costs by avoiding the tax. Since the factory is precluded from bargaining with the fishermen as in part (b), they will be unable to buy the net system. The next best option is to install the water filter system at a cost of $3500 (which is better than paying $4000 in taxes).
d) As Coase would argue, the outcomes in parts (a) and (b) are identical: as long as property rights are well-defined and transaction costs are low, private bargaining will result in the most efficient outcome. In this case, efficiency requires that the nets be used. However, in part (c), transactions costs were high enough to prevent bargaining so that only a "second best" outcome prevailed.

18. Tuna.
a) Free market price is $3.00 and output is 6,000,000 tuna where (private MB = private MC)
b) Socially optimal price is $4.50 and output is 3,000,000 tuna (where MSB = MSC)
c) Tax would be equal to the marginal external cost of tuna at the optimal output, namely, $2.25. Consumers would end up paying $1.50 of the tax (the change in market price from part (a) to part (b)).

19. This is in your notes and the text.

20. You can argue this one over a bottle of beer (assuming that you are over the age of 21).

21. Labor market.
a) No graph provided.
b) To solve for the equilibrium wage and employment, set labor demand equal to labor supply:

10 - L = L
L = 5

To get the wage, substitute L = 5 into either the labor demand or labor supply equation: W = 5.
c) If the marginal product of unskilled labor doubles, the new labor demand curve will be Wd = 20-L. If the compensation for acquiring skill rises by $2, then the labor supply curve will be Ws = L + 2. The new market equilibrium is where supply equals demand:

20 - L = L + 2
L = 9
which makesW = 11.

d) If labor supply is restricted to 5, the wage of high skilled workers can be determined by substituting L = 5 into the demand equation from part (c): W = 20 - (5) = 15. The wage differential is $10 (=15-5).
e) At a wage of $6, the quantity hired of labor is 4,000 hours while the quantity offered is 6,000 hours. This implies an excess supply of hours equal to 2,000.

22. Trout farmer versus the pesticide manufacturer.
a) The efficient amount of waste to dump into the lake is determined by the balancing of marginal costs and benefits. The marginal benefit of dumping waste into the lake is the amount of money that the pesticide company saves by avoiding trucking the waste elsewhere, namely, $100 per ton. The marginal cost of dumping can be determined from the chart as the additional cost to the fishermen for each extra ton that is dumped. Efficiency requires dumping to continue as long as MB > MC. This implies that no more than 3 tons be dumped.
b) If the trout farmer owns the lake, then, assuming transactions costs are low enough, private bargaining will result in 3 tons being dumped into the lake. The pesticide manufacturer would be willing to pay the trout farmer up to $100 for each ton dumped.
c) If the pesticide maker owns the lake, then, assuming transactions costs are low enough, private bargaining will result in 3 tons being dumped into the lake. The trout farmer would be willing to pay the pesticide maker up to $650 to rent space on the lake.
d) Tax = $100 per ton.
e) 3 tons will be dumped. The trout farmer will sell her permits to the pesticide manufacturer for around $100 each.

23. Median voter.
a) Lorenza. Proposed tax rate is whatever Lorenza wants, in this case, 30%. This tax rate will garner the most votes if an election were held.
b) Still 30%. The median voter's preference did not change.
c) The new proposal is now 25% since Eric becomes the median voter.

24. I'll leave this one for you to ponder.