CHAPTER 5

Frictions in the Labor Market

SUMMARY

In previous chapters, it has been assumed that firms were always wage takers; in other
words, a firm would have to hire at the market wage or all employees would leave.
Similarly, all labor costs have been assumed to be variable, directly proportionate to the
amount of time that an employee works. Thus we are implicitly assuming that it is easy
for workers to change firms and easy for firms to hire and fire workers. However, there
are usually frictions in the labor market which imply that it is costly for one or both
groups to make such changes.

The chapter first considers costs to workers of changing jobs, and thus how hiring
decisions are different when there are mobility costs. If mobility is costless, then workers
who have identical skills and who are performing the same job must receive equal wages.
However, real-world data does not generally support this prediction; there are significant
differences in wages for similar jobs in different geographic markets and for jobs
requiring similar skills within the same geographic markets. This implies that there must
be a cost to mobility, or low-wage workers would simply move to higher paying jobs.
Some mobility costs are monetary (printing résumés and moving, for example), but there
are also nonmonetary costs such as time, stress, and possible nonwage benefits of the
current job. These nonmonetary costs are likely to vary significantly between workers.

If there are positive mobility costs, then the supply of labor to the firm is now upward-
sloping rather than horizontal. As the firm raises wages, it will attract some workers
from other firms (presumably those with relatively lower mobility costs), and likewise, if
the firm lowers wages, it will lose some but not all workers. Mobility costs also
influence the elasticity of labor supply; relatively low mobility costs imply a more elastic
supply of labor. Upward-sloping labor supply curves facing individual firms are called
monopsonistic conditions.

A labor-market monopsonist has traditionally been defined as the sole employer of labor
in a given market, and thus the firm faces the market supply of labor. However, while
cases of pure monopsony power in labor markets are considered very rare at best, degrees
of monopsony power exist in a wide variety of labor markets. To determine optimal

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employment levels in the case of a firm having monopsony power, the given information
must include specification of the labor supply curve. For a monopsonist, labor supply is
upward sloping (because it is the sole employer of labor or because there are mobility
costs). Thus the marginal expense of hiring one more worker is not constant, because to
attract one more worker, the firm must raise the wage. Raising the wage for one worker
is assumed to require raising the wages of all workers, and thus the marginal expense for
the last worker is greater than the wage rate. (Assuming that the labor supply curve is
linear, it could be written in the form W = a + bL, where a and b are typically assumed to
be positive constants. Assuming that the firm is free to set any wage and that it pays the
same wage to all its workers, the marginal expense of labor is given by the expression
MEL = a + 2bL. This expression is then set equal to the marginal revenue product
expression to find the optimal employment level of the firm. The wage the workers
receive is found by taking the optimal employment level and substituting back into the
market supply equation.) Thus the monopsonist will hire fewer workers than an
equivalent competitive firm and will use its market power to pay them lower wages.

Within the same labor market, firms may have different marginal revenue product curves
(due to differences in plant and equipment and other factors influencing productivity) and
different labor supply curves (due to differences in the nonwage benefits of different
employers and other mobility cost factors that may vary between firms), and thus workers
with similar skills performing similar jobs may well earn very different wages.

Shifts in the supply of labor change the marginal expense of labor and thus change the
monopsonist’s desired level of employment and wage. For example, a decrease in the
supply of labor increases the marginal expense of labor and thus reduces desired
employment and increases the wage. In the long run, this may also lead the firm to
substitute capital for labor, and employment will decrease further.

Sometimes a monopsonist is bound by a government-enforced minimum wage law or has

negotiated a union scale wage, above the market equilibrium in either case. In these
situations, the stipulated wage functions as a portion of the firm’s ME L curve and again
the MEL is equated to the MRP L. Depending on the exact level at which the minimum or
union wage is set, it is possible for the firm’s optimal employment level to increase
relative to the level that is optimal when there is no market interference. Why?
Mandated wages increase the average cost of hiring, at least initially, but they can reduce
the marginal cost, since hiring one more worker no longer implies raising the wages of all
workers. With a lower marginal expense of labor, the firm is likely to wish to hire more
workers. In such cases, minimum wages can increase both the wage and the level of
employment (in contrast to the competitive model discussed in Chapter 4).

Since there are positive mobility costs, workers must decide whether it is worth incurring
the costs of a job search or whether it is better to stay with the existing job. While there

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 Chapter 5: Frictions in the Labor Market
are many reasons (some of which are discussed later in the text) why wages differ, one
reason may simply be luck. Some workers may initially be hired by high-wage firms and
stay there, while those who are initially matched with a low-wage employer may wish to
search more. More searching may result in a better match but also involves costs;
depending on the level of costs and the expected increase in the wage, it may not be
worth searching for a better match.

Costs of job search provide one explanation for why we observe that wages tend to
increase with overall labor-market experience and with time on the job. One reason why
job search is costly is because it takes time and effort, and job openings may appear
randomly. Thus workers who have been in the labor market longer will have had more
chances to acquire better offers and improve their matches (and thus earn higher wages).
Likewise, workers who have chosen to stay with an employer are probably those who
found a good match to begin with, and thus are observed to have higher wages. High
search costs may also be correlated with longer unemployment spells and higher
unemployment rates, as workers are more likely to turn down an offer if it is more costly
to search again once employed.

We now turn to issues relating to labor demand. The major friction on the demand side
of the labor market is the existence of quasi-fixed labor costs, costs that vary with the
number of workers hired, but not with the number of hours existing employees work. For
example, when an additional worker is hired to regularly work forty hours per week, the
firm will almost certainly incur hiring and training costs, contribute to the provision of
employee benefits (e.g., medical insurance), and be required by the government to make
payments on the worker’s behalf (e.g., contributions to the unemployment insurance
fund). These quasi-fixed costs fall into two categories: investments in the workforce
(such as hiring costs and training), and employee benefits.

Hiring costs involve such factors as advertising positions and screening applicants, as
well as the record-keeping costs of having another employee. Training costs are of three
types: the explicit cost of materials and trainers used in the training process; the implicit
cost of using existing employees and capital equipment to train the new employee; and
the implicit (opportunity) cost of the new employee’s time. Finally, there may be a cost
of terminating the worker, if necessary. Hiring and training costs are considered to be
investments because the costs occur in the present and have benefits in the future, and,
like most investments, are inherently risky.

Employee benefits include both legally mandated expenses such as contributions to

unemployment insurance Social Security programs and privately-provided benefits such
as medical insurance and vacation pay. These costs all vary with number of workers
rather than number of hours and thus are categorized as quasi-fixed costs. Treating the

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Chapter 5: Frictions in the Labor Market
average workweek of existing workers (H), and the number of workers (M), as two
distinct inputs, the cost-minimization rules developed in Chapter 3 require that

ME M ME H
= ,
MP M MP H

where ME refers to the marginal expense of an additional unit of the input M or H, and
MP refers to the marginal product of an additional unit of the input M or H. The ratio of
ME to MP gives the marginal cost of producing an additional unit of output using either
more workers or longer hours. The growth of quasi-fixed costs increases ME M,
destroying the equality, and raising the marginal cost of producing output using workers.
This creates a window of opportunity for the firm to produce the same output in a less
costly manner by substituting longer hours for some of its existing workers.

Some have proposed increasing MEH by increasing the overtime pay premium, with a
goal of expanding employment by making additional hours per worker more costly and
hence less attractive to employers. Such an increase in ME H, however, may not translate
into significant employment gains for a number of reasons. The optimal output of the
firm is likely to be reduced because of higher costs (a scale effect). Also, the firm may
shift to more capital-intensive production processes (a substitution effect). In addition,
the unemployed available for hire may not be good substitutes for those currently
working overtime, and the straight-time wage rate may be adjusted downwards so as to
keep total compensation the same.

The cost-minimization framework can also be adapted to look at the effect quasi-fixed
costs, such as those associated with the mandated provision of health insurance, have on
the choice between different categories of labor. For example, the choice between full-
time and part-time workers, or skilled and unskilled workers can be affected by the
growth of quasi-fixed costs in the same manner the employment/hours choice is affected.
Training costs create a different type of friction because they are often paid in part by the
workers themselves. For training to be desirable, it must be true that the training
increases the marginal productivity of the employee by more than it increases the wage
(so that the employer receives some return on the training investment), and secondly, the
worker must stay with the firm for long enough for the employer to receive this return.
In the case where the training expenditures are general (i.e., they make the employees
more productive in the eyes of all employers), all training expenses must be recovered
during the current or training period. This means that, in equilibrium, the wage must
equal marginal productivity less the training cost, meaning the employee is “paying” for
the training. In all future periods, we should expect the worker to be paid the value of his
productivity. If it were not so, workers, now more productive due to the training received
in the first period, could be bid away by competing firms. Firms will only pay for
general training if mobility costs are so high that trained workers will not seek a different
job (and thus the firm can recoup its training cost).

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 Chapter 5: Frictions in the Labor Market
However, in the case where the training expenditures are specific (i.e., they make the
employees more productive only in the eyes of the current employer), employers will pay
for at least some of the training costs with a training wage that exceeds marginal
productivity less the training cost. It is expected the firm will recover this training
investment gradually over time by setting the wage in future periods to be less than the
corresponding marginal product, provided the present value of the entire compensation
package remains at least competitive with what employees can attain elsewhere. The
firm is willing to incur some of the initial training cost because it can recoup these costs
by underpaying the worker (relative to productivity) in later periods; the worker is willing
to stay even though paid less than the value of marginal productivity in the future
because, with specific training, the value of the worker’s skills is higher at this firm than
it would be to other firms. In other words, where training is specific, the worker is
overpaid relative to productivity during training and underpaid relative to productivity in
later periods. Both workers and employers have invested in training, and thus both have
an incentive to make the employment relationship work and share in the rewards. The
share of the training cost borne by the employer will reflect the size of mobility costs as
well; if mobility costs are high, then the firm will be willing to pay more of the training
cost as it will not need to increase the post-training wage much in order to retain workers.

The gap that exists in equilibrium between the MP and the post-training wage gives the
worker some protection from temporary layoffs caused by declining demand. It will not
be in the firm’s interest to lay off workers as long as it is still recovering some of its
training investment. The gap between MP* and the post-training wage suggests that the
firm will not have to worry about the worker quitting since the wage it is paying is higher
than what the worker could earn elsewhere. Thus, the existence of quasi-fixed costs like
hiring and training costs can foster a more stable employment relationship. It can also
explain why average productivity tends to fall at the beginning of a recession. Firms may
“hoard” skilled labor, as they are unwilling to lay off trained employees. This surplus of
labor relative to utilized capital causes average productivity to appear to fall during a
recession, but it also means that firms can easily expand output without incurring new
hiring and training costs when the economy picks up.

An alternative strategy for responding to quasi-fixed hiring costs may be to attempt to

reduce them as much as possible. One method some firms use is to rely on credentials or
screening devices instead of closely investigating each individual applicant. This can
lead to statistical discrimination in the hiring process. For example, a firm may prefer
hiring men, not out of prejudice against women, but because data suggested on average,
that men had longer expected job tenures, which in turn would make the recovery of
hiring and training costs more likely. In situations where upper-level positions require
extensive firm specific knowledge, firms may rely on an internal labor market policy of
filling most positions from the ranks of current employees, thus learning about future
applicants gradually over time and eliminating the need for extensive screening.

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Chapter 5: Frictions in the Labor Market

REVIEW QUESTIONS

Choose the letter that represents the BEST response.

Definitions

1. The best definition of quasi-fixed costs is

a. nonwage labor costs.
b. hiring and training costs.
c. costs that vary with the number of workers employed.
d. costs that vary with the number of workers employed, but not with the number
of hours worked by existing employees.

2. Which of the following is not a quasi-fixed cost?

a. the hourly wage the firm pays
b. costs associated with a defined benefit pension
c. costs associated with a defined contribution pension
d. employer contributions to Social Security

*3. Consider a law that would require employers to provide the same package of
nonwage benefits offered to full-time employees to part-time employees on a prorated
basis. (For employees working 25 percent of the normal workweek, employers would
pay for 25 percent of the benefit package offered to full-time employees, and so on).
Assuming most part-time workers do not currently receive any benefits, such a law would
a. increase quasi-fixed costs.
b. increase labor costs that vary with hours worked.
c. have no effect on quasi-fixed costs.
d. both b and c.

4. Suppose that during the training period, a firm spends in real terms 3,000 per trainee
on labor and materials for its training program. Trainees in the program each produce
2,000 in output during the period, but could produce 3,500 if not occupied with training
activities. What is the total cost of training per worker to the firm?
a. 1,000
b. 1,500
c. 4,500
d. 6,500

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 Chapter 5: Frictions in the Labor Market
Use the following information in answering questions 5 - 8.

Suppose the firm has 500 employees each working a standard workweek of 40 hours.
The typical worker earns a real wage of 10 per hour and receives another 200 in weekly
benefits and training, 150 of which are quasi-fixed costs to the firm.

5. The marginal expense an employer faces when increasing its average workweek by an
hour (MEH) is approximately the sum of wage and variable benefit costs (on a per hour
basis) multiplied by the number of employees. Assuming no overtime wage premium, an
approximate value for MEH would be
a. 11.25.
b. 60.
c. 5,625.
d. 30,000.

6. Recomputing MEH assuming an overtime wage premium of 50 percent, an

approximate value would be
a. 16.875.
b. 8,125.
c. 8,437.5.
d. 11,250.

7. The marginal cost an employer faces when employing an additional worker (MEM) for
a typical workweek is approximately total weekly wages plus the employee benefits that
are variable costs plus the quasi-fixed costs. An approximate value for MEM would be
a. 15.
b. 550.
c. 600.
d. 7,500.

The Employment/Hours Trade-off

8. Suppose the marginal product of an additional worker is 50 and the marginal product
associated with expanding the workweek by 1 hour is 625. Using the MEH and MEM
values computed in questions 6 and 7, employ the rule for cost minimization to find the
firm’s optimal adjustment of its employment/hours mix.
a. Increase M and decrease H.
b. Increase H and decrease M.
c. Increase both H and M.
d. M and H should not change.

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Chapter 5: Frictions in the Labor Market
9. Increasing the overtime pay premium to double time may not result in overtime hours
being converted to additional employment because
a. firms may shift to more capital intensive production methods.
b. the optimal output of many firms is likely to be less.
c. the unemployed may not be substitutes in production for those currently
working overtime.
d. all of the above.

In questions 10 and 11, consider again the law that would require employers to provide
the same package of nonwage benefits offered to full-time employees to part-time
employees on a prorated basis. (For employees working 25 percent of the normal
workweek, employers would pay for 25 percent of the benefit package offered to full
time employees, and so on.) Also, assume most part-time workers do not currently
receive benefits.

*10. Holding output and capital constant, how would firms adjust the employment/hours
mix of part-time workers?
a. H would increase and M would decrease.
b. M would increase and H would decrease.
c. No change in M or H.
d. Can not be determined without more information on the ME and MP values.

*11. Holding output and capital constant, what effect would there be on the firm’s mix of
part-time and full-time workers?
a. Full-time workers would increase and part-time workers would decrease since
the marginal cost of part-time workers is now higher.
b. Full-time workers would decrease and part-time workers would decrease since
the marginal cost of part-time workers is now higher.
c. There would be no change in the mix of part-time and full-time workers since
part-time workers are still cheaper than full-time workers.
d. Part-time employment would actually increase since more people would now
want to work part-time.

In questions 12 and 13, consider a law that would mandate full health insurance coverage
for all employees. Assume that currently most, but not all, full-time employees have
health insurance coverage, but that few part-time employees are covered.

12. Holding output and capital constant, how would firms adjust the employment/hours
mix of part-time workers?
a. H would increase and M would decrease.
b. M would increase and H would decrease.
c. M and H would both decrease.
d. There would be no change in M or H.

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 Chapter 5: Frictions in the Labor Market
13. Holding output and capital constant, what effect would there be on the firm’s mix of
part-time and full-time workers?
a. Full-time workers would increase and part-time workers would decrease since
the marginal cost of part-time workers is now higher.
b. Full-time workers would decrease and part-time workers would decrease since
the marginal cost of part-time workers is now higher.
c. There would be no change in the mix of part-time and full-time workers since
part-time workers are still cheaper than full-time workers.
d. Part-time employment would actually increase since more people would now
want to work part-time.

Firms’ Hiring and Training Investments

14. A basketball team promises to pay its top draft choice in real terms a 1 million bonus
for signing with the team. The player receives 250,000 now and 250,000 each year for
the next three years. Assuming an interest rate of 6 percent, the present value of this
payment stream is
a. 918,253.
b. 925,251.
c. 943,396.
d. 1,093,654.

15. When a firm provides specific training, what happens to the gap between the post-
training wage and the marginal product as the market interest rate decreases?
a. It increases.
b. It decreases.
c. It stays the same.
d. It persists for a longer period of time.

16. Workers want the firm to pay some of the initial cost of specific training because
a. this will create a gap between the marginal product and the post-training wage.
b. workers will have some protection from layoffs due to declining demand.
c. the present value of the total compensation package will be higher.
d. both a and b.

17. Firms want the workers to pay some of the initial cost of specific training because
a. the firm will recover more of its investment in the workers.
b. the post-training wage will be farther above the workers’ marginal product in
other firms.
c. workers will be less likely to quit the firm.
d. both b and c.

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Chapter 5: Frictions in the Labor Market
18. Specifically trained workers will be predisposed to quit the firm when
a. the post-training wage is less than their marginal product at the firm.
b. the firm employs statistical discrimination.
c. the present value of the entire compensation scheme is not equivalent to what
can be earned elsewhere.
d. the firm utilizes an internal labor market strategy.

19. Firms faced with high hiring and training costs may
a. pay workers substantially less than their marginal product while they are in
training.
b. use statistical discrimination in hiring.
c. use internal labor markets.
d. all of the above.

20. If firms rely on old data that suggest women have shorter job tenures than men, firms
may
a. pay women less.
b. offer fewer training opportunities to women.
c. employ fewer women.
d. all of the above.

Mobility Costs and Monopsony

21. In a labor market that is monopsonistic

a. firms pay a competitive wage.
b. firms face an upward-sloping supply of labor curve.
c. are monopolists in output markets.
d. all of the above.

22. When mobility costs are high

a. the supply of labor is more elastic.
b. the supply of labor is less elastic.
c. the supply of labor is perfectly elastic.
d. the elasticity of supply of labor can no longer be determined.

*23. Assuming the market supply curve of labor is linear, the marginal expense of labor
curve for a monopsonist that pays all workers the same wage will
a. have a lower vertical intercept and the same slope when compared to the supply
curve.
b. have a lower vertical intercept and a steeper slope when compared to the supply
curve.
c. have a higher vertical intercept and the same slope when compared to the supply
curve.
d. have the same vertical intercept and a steeper slope when compared to the supply
curve.

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 Chapter 5: Frictions in the Labor Market
24. In a monopsonistic labor market where everyone is covered by the minimum wage, it
is possible for the minimum wage to lead to
a. higher employment.
b. lower employment.
c. no change in employment.
d. all of the above.

PROBLEMS

The Definition of Quasi-Fixed Costs

25. Consider a firm where workers are typically employed for 40 hours a week and 50
weeks a year. Workers at this firm earn a real wage of 12.50 per hour. Suppose the firm
is liable for a contribution on behalf of each worker to a fund that will help finance a
program of national health insurance. This contribution is 5 percent of the first 50,000
the worker earns. (50,000 is called the wage base.)

25a. How much would the firm typically have to contribute for each worker? Prove that
this contribution is not a quasi-fixed cost.

25b. Holding the typical hours and the wage base constant, at what wage level would
this contribution become a quasi-fixed cost? On the other hand, holding typical hours
and the wage constant, what wage base would transform this contribution into a quasi-
fixed cost?

The Employment/Hours Trade-off

26. Immigration laws now require employers to determine whether newly hired workers
are legally residing in the country.

26a. Assuming for simplicity that output and capital are constant, what effect does this
law have on the employment/hours mix used by firms?

26b. How would the analysis be different if output were not constant?

27. Suppose the firm currently employs 500 workers at 40 hours per worker per week
and that the following relationship holds.

ME M 800 ME H 9 , 000
= =2> = =1 .5 .
MP M 400 MP H 6 , 000

Prove that the firm is not at an equilibrium mix of workers and hours by showing there is
a window of opportunity for it to reduce its total cost.

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Chapter 5: Frictions in the Labor Market
Firms’ Hiring and Training Investments

28. Consider a multiperiod labor demand scenario where for simplicity the interest rate is
assumed to be zero. Assume the firm makes real specific training expenditures of 200
per worker, and the expected length of employment (after training) is 15 months. In
equilibrium, the workers’ inherent marginal productivity is 225. During training the
workers have a marginal product of 200 and are paid a real wage of 150. After training
the marginal product is expected to rise to 250. Also, assume an equal wage in the post-
training periods.

28a. Find the maximum monthly wage the workers could be offered in the post-training
periods if the firm wants to recover fully its training costs by the time the workers are
expected to leave. Will the training program be attractive to the workers?

28b. In this scenario, workers and the firm share in the cost of training during the initial
period since workers are contributing a marginal product of 200 but are only being paid
150. What would happen to the post-training wage if the firm bore the full cost of
training? Why does the firm want the workers to initially bear some of the cost of
training?

28c. What would happen to the post-training wage if the worker initially bore the entire
cost of training? Why does the worker want the firm initially to bear some of the cost of
training?

28d. Suppose the expected length of employment after training is only 10 months. What
does this do to the gap between the marginal product and the wage the workers receive?

28e. Assuming a monthly minimum wage of 225, could the firm recover its training
costs in only 5 months after training? What is the shortest time over which the firm could
recover its training costs?

28f. Given the initial information in the problem, what is the highest the inherent
marginal product of the workers could be and still make the recovery of training costs
possible?

29. Consider a firm that incurs real expenditures for specific training in the current
period equal to 150 per worker. During the training period, the workers have a marginal
product of 400 and are paid a real wage of 375. Next year, after the training is over,
marginal productivity is expected to rise to 535.

29a. If the firm wanted to recover all its training costs in the initial year after training,
what would be the maximum wage it could offer the workers, assuming the interest rate
is 6 percent?

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 Chapter 5: Frictions in the Labor Market
29b. Are workers likely to find this training program attractive?

30. A firm expects to hire workers for three years. The interest rate is constant at 6
percent. In the current period the firm incurs real training costs of 500 per worker.
Suppose the workers’ marginal product during training is 1,800 and then rises to 2,500 in
the second year and 2,800 in the third.

30a. If the firm pays the workers a real wage of 1,600 during the training year, 2,200
during the second year, and 2,600 during the third year, will the firm recover its training
costs on a present value basis?

30b. Do you think such a pay schedule could persist over time?

31. A firm expects to hire workers for three years. The interest rate is constant at 6
percent. In the current period the firm incurs real general training expenditures of 3 per
worker. A typical worker’s marginal product during training is 5.50. In the second and
third years, the worker’s marginal product is expected to increase to 9.

31a. To fully recover its training costs, what real wage will the firm offer to pay the
worker in each year?

31b. Why could the firm not pay the worker a post-training wage of 7.5?

31c. Suppose there is a minimum wage of 4 in this economy. How would this change
your analysis?

*32. Suppose a firm has a marginal product schedule given by the equation

MPL = 50 - 2L,

where L is the number of workers. Suppose the money wage is $40 and the product price
is $2.

*32a. Find the optimal employment level assuming no training investment.

*32b. If the price of the product the firm sells falls to $1, find the new employment level.

*32c. Suppose that at the employment level found in 28a, the firm only paid the workers
a money wage of $20 because it was recovering an earlier investment in specific training.
Find the new employment level when the product price falls to $1.

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Chapter 5: Frictions in the Labor Market

APPLICATIONS

Effects of Equal Pay Laws

33. Consider a firm that incurs expenditures for specific training in the current period
equal to 3,000 per worker in real terms. During the training period, workers and the firm
share the cost of training. The firm pays its workers a real wage of 10,500 and their
marginal product is 11,000. Next year, after the training is over, the marginal product is
expected to rise to 16,000, and then to 17,000 the year after that. The interest rate is 6
percent.

33a. Robin, a college senior, applies for the job and promises to stay two years after the
training program is complete. Robin has other offers to work at 11,500, but they do not
offer any training. If the firm wanted to recover all its training costs by the time Robin
leaves, what would be the maximum wage it could offer in the post-training years?
Assume an equal wage in the years following training.

33b. Would the firm be likely to attract Robin with this offer?

33c. A short time later, Ann also applies to this firm. She is a comparable applicant in
all ways except that she plans to stay only one year after training is complete. What
would be the maximum wage the firm could offer Ann in the post-training year if they
want to recover their training investment?

33d. Assuming she has had offers similar to those made to Robin, would the firm be
likely to attract Ann with its offer?

33e. Suppose the firm is required by law to pay workers who do comparable jobs the
same wage. Discuss the likely effects on Ann.

Effects of Minimum Wage Laws

34. In April 1990, a lower minimum wage was instituted for teenagers. It applied to 16-
to 19-year-olds for the first six months of their first job.

34a. How would you predict such a youth subminimum wage would affect the likelihood
of teens receiving on-the-job training? Would general or specific training opportunities
be most affected?
34b. Construct a simple numerical example to illustrate your reasoning.
Effects of Subsidized Training
35. Under the Job Training Partnership Act, the government substantially subsidized
employer costs incurred in training certain disadvantaged groups in the population.
Refugees from the Vietnam War, for example, were a group targeted by the program,
although other groups also qualified.

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 Chapter 5: Frictions in the Labor Market
35a. How would this program affect a firm’s employment/hours choice?

35b. How would this program affect the job stability of the targeted groups?

Monopsony

*36. Consider a monopsonist with a production function given by equation

Q = LK.

The firm’s marginal product is given by the equation

MPL = K.

The labor supply curve for this market is given by the equation

W = 3L.

Suppose the firm has monopoly power in the output market and faces a demand curve for
its product given by the equation

P = 64 - Q.

The level of capital is held constant at 3 units in the short run. The price of capital is $5
per unit.

*36a. Find the equation for the marginal revenue product of labor (MRPL).

*36b. What simplifying assumption about the firm’s production process was made in
this problem that is not typically made when examining the firm’s short-run demand for
labor? Why do you suppose it was made in this problem?

*36c. Find the equation for the marginal expense of labor (MEL).

36d. Calculate the optimal level of labor for this firm.

36e. Calculate the wage paid to the typical worker and the resulting output, price, and
profits for the firm.

36f. Suppose a minimum wage of $30 is mandated in this market. Find the optimal
employment level for the monopsonist. Compare your result with the answer to 36d.
Finally, suppose the minimum wage was set at $66. Find the optimal employment level.

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