AK 11.3

# AK 11.3 - ECON 211 Fall 2009 Answer Key for Problem Set 11...

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ECON 211, Fall 2009 Answer Key for Problem Set 11 Part I. Graded Questions Problem 1: (30 points) Marty’s Frozen Yogurt has the production function per day shown in the accompanying table. The equilibrium wage rate for a worker is \$80 per day. Each cup of frozen yogurt sells for \$2. Quantity of Quantity of labor frozen yogurt (workers) (cups) 0 0 1 110 2 200 3 270 4 300 5 320 6 330 a. (15 points) Calculate the marginal product of labor for each worker and the value of the marginal product of labor per worker. The accompanying table shows the marginal product of labor (MPL) and the value of the marginal product of labor (VMPL) of each worker. Remember that VMPL = P × MPL. Here that means that VMPL = \$2 × MPL.

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b. (15 points) How many workers should Marty employ? Marty should employ 3 workers. The value of the marginal product of the third worker (\$140) is above the wage rate of \$80: Marty should hire the third worker. But the fourth worker’s value of the marginal product is only \$60. This is less than Marty would have to pay this worker, so Marty should not hire a fourth worker. Problem 2: (30 points) You are considering buying a second-hand Volkswagen. From reading car magazines, you know that half of all Volkswagens have problems of some kind (they are “lemons”) and the other half run just fine (they are “plums”). If you knew that you were getting a plum, you would be willing to pay \$10,000 for it: this is how much a plum is worth to you. You would also be willing to buy a lemon, but only if its price was no more than \$4,000: this is how much a lemon is worth to you. And someone who owns a plum would be willing to sell it at any price above \$8,000. Someone who owns a lemon would be willing to sell it for any price above \$2,000. a. (10 points) For now, suppose that you can immediately tell whether the car that you are being offered is a lemon or a plum. Suppose someone offers you a plum. Will there be trade? You value a plum at \$10,000: you would be willing to pay any price up to \$10,000 to buy it. The seller values a plum at \$8,000: she would be willing to sell her car at any price above \$8,000. So there is room for trade: at some price between \$8,000 and \$10,000, both buyer and seller will want to engage in trade with each other. Now suppose that the seller has private information about the car she is selling: the seller knows whether she has a lemon or a plum. But when the seller offers you a Volkswagen, you do not know whether it is a lemon or a plum. So this is a situation of adverse selection. b.
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AK 11.3 - ECON 211 Fall 2009 Answer Key for Problem Set 11...

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