S-HW3 - University of Illinois at Urbana-Champaign...

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University of Illinois at Urbana-Champaign Professor Ron Laschever, ECON 440, Spring 2010 1 Problem set #3 Answer Key 1. Present a formula to calculate the economic loss using the guidelines that the special master prescribed. You may assume that the person is a 28-year-old single male. In your answer, be sure to address how many additional years you assume an individual would work. Would you discount earnings that a person would have earned in the future? If so, at what rate? Would your answer change in the case of a female? Why? [15 Pts] Let w represent a person’s average wage over the past three years (we could find that out by looking at their tax returns, but if you just assumed some number, that’s fine too). Let T represent the number of additional years a person is assumed to work. Finally, let r represent some risk-free interest rate. In the year after a person died, we assume he would have earned w ; But the person wouldn’t have received this for a year. Referring back to our discussion in the previous class, a dollar received in one year is equivalent to 1/(1+r) today, where r is some personal discount rate. Thus, w in a year is only worth w /(1+ r ) today. Similarly, in two years a person would have been paid w , which is worth w/(1+r) 2 today. That is, a person’s total (economic) compensation can be expressed as: = + = + + + + + + + + = T t t T r w Total or r w r w r w r w Total 1 3 2 ) 1 ( , ) 1 ( ... ) 1 ( ) 1 ( 1 It would probably be nice to plug in some values. First, what is the value for T? Since we know the person is 28 the question is really when is a 28-year-old male going to retire? There are calculators that predict that. Since the average retirement age is falling, it might seem reasonable to assume that younger workers who died on 9/11 would have retired earlier than older workers who died. It would also seem reasonable to project different retirement ages for people with different characteristics (i.e. low versus high education, white collar versus blue collar jobs, etc.). Similarly, even though the gap between them is closing, men still tend to spend more years in the labor market than do women. On the one hand, we might want to use all available information about a person to project their retirement age. On the other hand, we might feel guided by a principle to treat people as similarly as possible – either because it’s a more fair method, or because it’s a more simple method. The Special Master balanced these ideas and only used a person’s age to determine a person’s retirement age (younger people were assumed to retire earlier than older people). Men and women who were the same age were assumed to work the same
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This note was uploaded on 10/24/2010 for the course ECON 440 taught by Professor Staff during the Spring '08 term at University of Illinois, Urbana Champaign.

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S-HW3 - University of Illinois at Urbana-Champaign...

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