hw1_ak - 180.351 Labor Economics Homework Assignment 1...

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180.351 Labor Economics Homework Assignment 1 Answer keys Yuya Takahashi February 21 2014 1. (36 points in total) Answer the following questions (drawing a graph helps a lot!). (a) The OLS estimate is most likely inconsistent because the unobserved ability i and the years of schooling would probably be correlated with each other. The costs of completing a school/college are lower for students with high cognitive abilities, for example. (b) The % change in the wage is (10 8) / 8 = 0 . 25 , while the % change in hours is (30 20) / 20 = 0 . 5 . Thus, the labor supply elasticity is 0 . 5 / 0 . 25 = 2 . (c) This is the situation where the income e § ect and substitution e § ect exactly o § set each other. In page 15 of Lecture 3 slides, point R happens to be right above point P , so that the hours of work did not change after the increase in wage. (d) When the wage level increases, the budget line rotates clockwise, and thus workers can attain a higher level of utility. The change in worker’s optimal labor-leisure choice can be decomposed into two e § ects: income and substitution e § ects. We assume that leisure is a normal good, so the income e § ect increases leisure consumption (decrease labor supply). On the other hand, the substitution e § ect decreases leisure consumption (increase labor supply), since a higher wage means that leisure is more expensive. If the income e § ect dominates the substitution e § ect, the labor supply curve is downward-sloping, otherwise it is upward-sloping. See pages 14-19 of Lecture 3 slides. (e) As discussed in (d) above, the theoretical ambiguity comes from the fact that the income e § ect and substitution e § ect have countervailing forces. However, for workers who are not currently working, there is no income e §
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