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ECO101H1 (177)
Chapter 6

Chapter 6 Typical Question and Answers

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George Ignatieff

CHAPTER 6 6-1. Politicians who support the green movement often argue that it is profitable for firms to pursue a strategy that is “environmentally correct” (for example, by building factories that do not pollute and are not noisy), because workers will be willing to work in environmentally correct factories at a lower wage rate. Evaluate the validity of this claim. If it is profitable for firms to build factories that do not pollute and are not noisy, they would have been built already. After all, firms could build these profit-maximizing factories and attract persons to work at these factories at lower wages because no compensating differential would be needed. The fact that compensating differentials exist and that governments attempt to regulate the quality of the workplace implies that providing these amenities to workers is more costly than cost-saving. 6-2. Suppose wages and health insurance are the only two job characteristics workers care about. Describe the relationship between the wage level in a particular job and whether the job offers health insurance if the government does not require employers to offer health insurance to their workers. What happens to the wage structure if the government requires all firms to provide a standard package of health insurance to their workers? When the government does not require employers to offer health insurance, workers would prefer to work in those firms that offer health insurance and would be willing to pay for the right to work in such firms (assuming that all workers prefer to have health insurance). In other words, jobs that offered health insurance would pay less than jobs that did not offer such plans. When the government mandates that all employers offer health insurance to workers, the wage in those firms that had provided either no health insurance or a “substandard” package would fall and the wage would eventually be the same in all jobs. 6-3. Workers choose to work a risky or a safe job. Suppose there are 100 workers in the economy. Worker 1’s reservation price (for accepting the risky job) is $1; worker 2’s reservation price is $2, and so on. Because of technological reasons, there are only 10 risky jobs. What is the equilibrium wage differential between safe and risky jobs? Which workers will be employed at the risky firm? Suppose now that an advertising campaign paid for by the employers who offer risky jobs stresses the excitement associated with “the thrill of injury,” and this campaign changes the attitudes of the work force toward being employed in a risky job. Worker 1 now has a reservation price of -$10 (that is, she is willing to pay $10 for the right to work in the risky job); worker 2’s reservation price is -$9, and so on. There are still only 10 risky jobs. What is the new equilibrium wage differential? The supply curve to the risky job is given by the fact that worker 1 has a reservation price of $1, worker 2 has a reservation price of $2, and so on. As the figure below illustrates, this supply curve (given bys upward sloping, and has a slope of 1. The demand curve ( D ) for risky jobs is perfectly inelastic at 10 jobs. Market equilibrium is attained where supply equals demand so that 10 workers are employed in risky jobs; the market compensating wage differential is $10 since this is what it takes to entice the marginal (tenth) worker to accept a job offer from a risky firm. Note that the firm employs those workers who least mind being exposed to risk. If tastes towards risk change, the supply curve shifts down to′ and the market equilibrium is attained when the compensating wage differential is -$1. This is the compensating differential required to hire the marginal worker (that is, the 10th worker). Note that this compensating differential implies that even 37 though most workers (from worker 12 onwards) dislike risk, the market determines that risky jobs will pay lessthan safe jobs. Compensating DifferentialD S S′ 10 1 10 -1 Employment -10 6-4. Suppose all workers have the same preferences represented by Uw, x 2 where w is the wage and x is the proportion of the firm’s air that is composed of toxic pollutants. There are only two types of jobs in the economy, a clean job (x = 0) and a dirty job (x = 1). Let 0be the wage paid by the clean job and w 1 be the wage paid by the polluted job. If the clean job pays $16 per hour, what is the wage in dirty jobs? What is the compensating wage differential? If all persons have the same preferences regarding working in a job with polluted air, market equilibrium requires that the utility offered by the clean job be the same as the utility offered by the dirty job, otherwise all workers would move to the job that offers the higher utility. This implies that: w − 2(0) = w − 2(1) => 16= w − 2. 0 1 1 Solving forw implies thatw = $36. The compensating wage differential, therefore, is $20. 1 1 38 6-5. Suppose a drop in the compensating wage differential between risky jobs and safe jobs has been observed. Two explanations have been put forward: • Engineering advances have made it less costly to create a safe working environment. • The phenomenal success of a new action serial “Die On The Job!” has imbued millions of viewers with a romantic perception of work-related risks. Using supply and demand diagrams show how each of the two developments can explain the drop in the compensating wage differential. Can information on the number of workers employed in the risky occupation help determine which explanation is the right one? The engineering advances make it cheaper for firms to offer safe jobs, and hence reduce the gain from switching from a safe environment to a risky one. This will shift the demand curve for risky jobs in and reduce the compensating wage differential (Figure 1). Note that the equilibrium number of workers in risky jobs goes down. The glamorization of job-related risks may make people more willing to take these risks. This shifts supply to the right and reduces the compensating differential (Figure 2). Note that the equilibrium number of workers in risky jobs goes up. Thus, information on whether employment in the risky sector increased or decreased can help discern between the two competing explanations. Figure 1. Labor Market for Risky Jobs Compensating Differential Supply (w 1 w )0 old (w 1– w 0 new Old Demand New Demand E new E old Number of Workers in Risky Jobs 39 Figure 2. Labor Market for Risky Jobs Compensating Old Supply Differential New Supply (w1– w 0 old (w1 – w0 new Demand Eold E new Number of Workers in Risky Jobs 6-6. Consider a competitive economy that has four differen
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