Economics 151aps4ak

Economics 151aps4ak - Compensating Differential...

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Compensating Differential Supply Old Demand E new E old Number of Workers in Risky Jobs (w 1 – w 0 ) old (w 1 – w 0 ) new New Demand Compensating Differential Old Supply New Supply Demand E old E new Number of Workers in Risky Jobs (w 1 – w 0 ) old (w 1 – w 0 ) new Economics 151a Spring 2008 Homework 4 - Solutions 6-3.Suppose there are 100 workers in the economy in which all workers must choose to work a risky or a safe job. 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. (a) What is the equilibrium wage differential between safe and risky jobs? Which workers will be employed at the risky firm? 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 by S ) is 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. (b) 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? If tastes towards risk change, the supply curve shifts down to S 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
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This note was uploaded on 10/15/2009 for the course ECON 151A taught by Professor Miller during the Spring '06 term at UC Davis.

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Economics 151aps4ak - Compensating Differential...

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