University of Illinois at Urbana-Champaign
Professor Ron Laschever, ECON 440, Spring 2011
Problem set #5
Due at the start of class on March 17
Answer problem 1 on page 493 in the Borjas textbook (this is problem 12-1 on page 483 in the
fourth edition). ANSWER PROBLEM #11-1 NOT THE REVIEW QUESTION #1. . [15
Workers 1 through 34 will find it optimal to be paid the time-rate, while workers 36 through 100 will find
it optimal to work for the piece-rate firm. Worker 35 is indifferent between the two. More productive
workers will flock to the piece-rate firm. If the price of output is cut by half, then worker 1’s value of
marginal product falls to 50 cents, worker 2’s to $1, etc. If the time-rate firm continues to pay $35 per
hour, then workers 1 through 69 will choose to work there (and worker 70 is indifferent between the two
firms). If, as is more likely, the time-rate firm reduces its wage rate to $17.50 per hour, then the sorting
between the firms will not change.
Small firms are less likely than large firms to offer health insurance to their employees. One
reason for this is that health insurance tends to cost more for small firms than for large firms.
Explain why health insurance costs more for smaller insurance pools.
Insurance is cheaper for larger groups of people for three primary reasons:
Larger groups reduce the total risk, which lowers the cost of insurance.
Larger groups reduce the possibility of adverse selection.
Larger groups are able to spread out the fixed costs of providing insurance among more people.
In addition, since health expenditures are more variable from year to year in small groups, insurance
premiums are also more variable, especially when health insurance is experience rated.
This variation in
premiums dissuades many small firms from offering insurance, though it doesn’t necessarily make the
insurance more expensive.
Companies are increasingly offering more “lifestyle” and non-traditional benefits, such as on-
site fitness, medical, and dining facilities. For example, go to
and check out the
benefits that Google offers their U.S.-based employees (or, go to
for “Google U.S. Benefits”). Two motivations we discussed in class for why firms offer benefits
are, first, that firms may be able to purchase the benefit at a lower cost than could the
employee. Second, by offering a particular benefit, the firm may find it easier to recruit certain
types of workers. .
[3 x 5 = 15 Points]
Relate these two motivations to Google’s policy of providing free on-site meals and a fitness