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test 01, 2010

9 Pages

Course Code
Michael H O

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JUNE 7, 2010
TIME: 3 ± 4:30 AM (90 MINUTES)
(i) This test should be answered in BALLPOINT PEN and students who attempt the test in pencil would
surrender their right to request for re-assessment.
(ii) Answer ALL questions ONLY in the designated pages. Clearly LABELED the answer to EACH PART
of every question. Make sure your HANDWRITING is LEGIBLE.
(iii) Do NOT SEPARATE any page from this test.
Page 2 of 9
1. Generic drug manufacturers offer subsidy to pharmacies in Ontario to carry their drugs, which reduces the
cost of hiring pharmacists that pharmacies pay. Suppose licensed pharmacists can practice in both
Manitoba and Ontario. Assume the wages for pharmacists are the same in these two provinces at this
moment. (a) Use a set of two properly labeled diagrams (side-by-side) to help you explain the adjustment
mechanism that would restore equalization of wages for pharmacists in these provinces if Ontario
succeeds in eliminating the generic drug PDQXIDFWXUHUV¶VXEVLG\WRSKDUPDFLHV(b) Briefly discuss three
factors that might prevent such mechanism from functioning. Answer this question according to lecture
Diagrams: 5 marks
Explanation: (a) 10 marks and (b) 3 marks
(5 marks)
(a) At this moment, the wages for pharmacists in Ontario and Manitoba are the same at S5 in which 0È
pharmacists are employed in Ontario and 0Æ
5 pharmacists are employed in Manitoba. If Ontario succeeds
LQHOLPLQDWLQJWKHJHQHULFGUXJPDQXIDFWXUHUV¶VXEVLG\WRpharmacies, then the cost of hiring pharmacists
that pharmacies pay would rise and the demand for pharmacists by pharmacies would decrease (shifting
the demand &È to &È
ñ). Then, at S5, there will be excess supply of pharmacists, which pushes the wage
down to S6 and fewer pharmacists will be employed (0È
5 to 0È
6). Given the fact that pharmacists in
Manitoba are earning a higher wage :S5; than their counterparts in Ontario :S6; and some pharmacists
have lost their jobs in Ontario :0È
6;, some pharmacists will move to Manitoba and causing a
decrease in supply of pharmacists in Ontario (shifting the supply 5È to the left towards 5È
ñ). This helps the
wage in Ontario to rise from S6, but with even fewer pharmacists employed in Ontario.
The relocation of pharmacists from Ontario to Manitoba increases the supply of pharmacists in Manitoba
(shifting the supply 5Æ to the right towards 5Æ
ñ), which creates an excess supply at S5. The excess supply
will insert downward pressure on the wage. Wage equalization is restored when the supply of pharmacists
has shifted to 5È
ñ in Ontario and 5Æ
ñ in Manitoba such that the equilibrium market wages in these market
are equalized at S7. The wage of pharmacists drops in these provinces, fewer pharmacists are employed
in Ontario while more pharmacists are employed in Manitoba. (10 marks)
(b) Reasons for persistent wage differential in the long run: (i) lack of information such pharmacists in
Ontario do not learn about the higher wage in Manitoba; (ii) relocation costs (including moving cost and
differential does not justify relocation from Ontario to Manitoba; and (iii) institutional restrictions
(licensing requirements) in order to protect the incomes of pharmacists in each province. (3 marks)
Page 3 of 9
2. Suppose the utility function of an individual depends on the consumption of leisure :º; and the composite
good :%; with 6 being the maximum number of hours of leisure he can consume (the basic income-leisure
model). Assume this individual has no non-labour income, but he can earn an hourly wage of S if he
chooses to work. Use the diagram provided below to show and explain why point ' is not a utility-
maximizing outcome and which direction this individual should go in maximizing his utility under (a) the
internal required tradeoff and market offered tradeoff approach, and (b) the marginal benefit-cost
Diagram: 4 marks
Explanation: (a) 11 marks and (b) 11 marks
(4 marks)
(a) The quantity of the composite good that this individual can afford depends solely on his labour income
and his labour income :6Fº;S. Then, the budget line :$.; represents the constraint on the maximum
amount of leisure and composite good this individual can consume.
Under the internal required tradeoff and market offered tradeoff approach, suppose this individual plans to
move from point ' to point # on the budget line in an attempt to maximize his utility by giving up one
hour of º (working one more hour). According to his internal required tradeoff, he must receive at least Ü
units of % in return to remain at the same utility level (on 74). However, the market offered tradeoff is
only Ù units of % (on $.). Since ÙOÜ, if this individual moves to point #, then he will be worse off
when the market offered tradeoff falls short of the internal required tradeoff.

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U NIVERSITY OF T ORONTO D EPARTMENT OF E CONOMICS ECO361 L ABOUR ECONOMICS M ICHAEL H O TEST 1 SOLUTIONS JUNE7, 2010 TIME: 3 4:30 AMINUTES) VENUE: SE2082 IMPORTANT : (i)This test should be answered in BALLPOINT PEN and students who attempt the test in pencil would surrender their right to request for re-assessment. (iiof every question. Make sure your HANDWRITING is LEGIBLE.y LABELED the answer to EACH PART (iiDo NOT SEPARATE any page from this test. STUDENT TUDENT NAM: ID# Q1 Q2 Q3 Q4 Q5 Total Marks 18 26 10 23 23 100 Diagram(s) (a) (b) (c) Sub-Total: Page 1 of 9
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