Download Foundations of Economics, 3e (Bade/Parkin)

Foundations of Economics, 3e (Bade/Parkin) - Testbank 3
Chapter 18 Demand and Supply in Factor Markets
1) What is the stock market?
Answer: The stock market is the financial market in which shares of companies are traded. A share of a
company is an entitlement to a share of the profits of the company because a share represents partial
ownership of the company.
Topic: Stock market
Skill: Level 1: Definition
Objective: Checkpoint 18.1
Author: JC
2) Why is the demand for labor a "derived demand?"
Answer: The demand for labor arises because we need to use labor to produce a good or service. The demand
for a good, for example an apple, is a direct demand. However, the demand for an apple picker is a
derived demand. It is derived from our need to use labor to produce the good we demand, the apple.
Topic: Derived demand
Skill: Level 2: Using definitions
Objective: Checkpoint 18.2
Author: SA
3) What is the value of marginal product of labor? What is the formula that can be used to calculate? How does
the value of the marginal product affect how much labor a firm hires?
Answer: The value of marginal product of labor tells the additional amount of revenue the firm earns by hiring
an extra unit of labor, so it is the value to a firm of hiring one more unit of labor. The value of marginal
product equals the price of a unit of output multiplied by the marginal product of labor. The firm
maximizes its profit by hiring up to the point where the value of marginal product equals the wage
rate.
Topic: Value of marginal product
Skill: Level 2: Using definitions
Objective: Checkpoint 18.2
Author: CD
4) "As the quantity of labor hired increases, the value of the marginal product stays constant as long as the
wage rate is constant for all workers." Is the previous statement correct or incorrect? Explain your answer.
Answer: The statement is incorrect. The value of the marginal product equals the price of a unit of output times
the marginal product. As more workers are employed, the marginal product decreases, and so the
value of the marginal product decreases.
Topic: Value of marginal product
Skill: Level 2: Using definitions
Objective: Checkpoint 18.2
Author: WM
5) "The decision to employ an additional unit of labor depends on whether the value of the marginal product is
greater than or less than the wage rate." Is the previous statement correct or incorrect?
Answer: The statement is correct. If the value of the marginal product exceeds the wage rate, the worker is
hired; if the value of the marginal product is less than the wage rate, the worker is not hired.
Topic: Value of marginal product
Skill: Level 2: Using definitions
Objective: Checkpoint 18.2
Author: SA
6) What is the relationship between a firm's value of the marginal product curve for labor and its demand for
labor curve? Explain why this relationship exists.
Answer: The value of the marginal product curve for labor is the same as the demand for labor curve. The
curves are the same because of the firm's profit-maximizing decisions. In order to maximize its profit,
a firm hires the number of workers that sets the wage rate equal to the value of the marginal product.
So at any wage rate, the firm uses its value of the marginal product curve to determine how many
workers to hire. But that is what the demand for labor curve shows: how many workers the firm hires
at any wage rate. As a result, the value of the marginal product for labor is the same as the firm's
demand for labor curve.
Topic: Demand for labor curve
Skill: Level 3: Using models
Objective: Checkpoint 18.2
Author: MR
7) What factors other than the wage rate influence the demand for labor? How is demand affected by changes
in these factors?
Answer: The demand for labor is influenced by changes in the price of the firm's output, the prices of other
factors of production, and technology.
The demand for labor is based on the value of marginal product, which is equal to the marginal
product times the price. When the price of the firm's output increases, the value of marginal product
increases, making hiring more workers profitable. So when the price of the firm's output increases, so
does its demand for labor.
The prices of other factors of production also influence the demand for labor. The different factors
of production can be substitutes for each other. For instance, if the price of capital falls relative to the
wage rate, a firm will substitute capital for labor, which will decrease the demand for labor. However,
if the cheaper capital results in a large increase in production, it is possible that the demand for labor
will increase.
Technology can either increase or decrease the demand for labor, depending on whether the
technology allows firms to replace workers with capital (which decreases the demand for labor) or
makes the labor more productive (which increases the demand for labor).
Topic: Demand for labor
Skill: Level 3: Using models
Objective: Checkpoint 18.2
Author: SB
8) What factors shift the demand for labor curve? Briefly describe the effect of each.
Answer: Three factors shift the demand for labor curve: the price of the firm's output, the prices of other factors
of production, and technology. When the price of the firm's output rises, the firms' demand for labor
increases and its demand for labor curve shifts rightward. These changes occur because when the
price of output rises, the value of marginal product increases, which means the value to the firm of
hiring additional workers rises.
When the prices of other factors of production change, the demand for labor changes. When the price
of capital rises, the firm is motivated to use more labor and less capital. The firm's demand for labor
increases and the demand for labor curve shifts rightward. When the price of capital falls, more capital
is demanded and, unless the fall in the price of capital increases the scale of the firm's operations, less
labor is demanded. The demand for labor curve shifts leftward.
Changes in technology affect the demand for labor in a more complex way. Depending on the type of
advance in technology, the demand for different types of labor might increase or decrease. If the
demand for a type of labor increases, its demand curve shifts rightward; if the demand for another
type of labor decreases, its demand curve shifts leftward.
Topic: Demand for labor
Skill: Level 3: Using models
Objective: Checkpoint 18.2
Author: CD
9) "In order for Charlie Trotter's, an upscale restaurant in Chicago, to maximize profit from the employment of
chefs, the restaurant should hire chefs up to the point where the value of the marginal product equals the
wage rate for chefs." Is the statement correct or incorrect?
Answer: The statement is correct. In order for any firm to maximize its profit, it hires workers until the wage
rate equals the value of the marginal product.
Topic: Profit maximization
Skill: Level 2: Using definitions
Objective: Checkpoint 18.2
Author: JC
10) Why does a profit-maximizing firm hire labor up to the point where the value of the marginal product
equals the wage rate?
Answer: If a company stopped adding workers at the point where the wage rate was less than the value of the
marginal product of labor, the firm could hire more workers and its profit would increase. Why?
Because the return from the workers, the value of the marginal product, exceeds the cost of hiring the
workers. Since the marginal product of labor decreases as more workers are employed, as more
workers are added, the marginal product of labor and hence the value of the marginal product
decreases. Eventually the firm will reach the point at which the value of the marginal product equals
the wage rate. If still more workers are employed, then the wage the firm must pay the workers
exceeds the value of the marginal product. These workers would contribute losses to the firm. So only
when the value of the marginal product equals the wage rate can the firm not increase its profit by
changing the quantity of workers it employs.
Topic: Profit maximization
Skill: Level 3: Using models
Objective: Checkpoint 18.2
Author: JC
11) Why do baseball players make so much money, while kindergarten teachers in private schools make so
much less? In your answer, discuss the value of the marginal product and the actions of profit-maximizing
firms.
Answer: Let us consider the value of the marginal product of two workers, Alex Rodriquez, shortstop for the
New York Yankees, and any kindergarten teacher in the United States.
The value of marginal product of labor is the marginal product of labor multiplied by the price of
the output the laborer produces. While it is fairly difficult to measure the marginal product of a
kindergarten teacher (the benefits of his or her work take years to appear), it is clear that the price that
can be charged is much lower than the price that can be charged for baseball games. Why? Mr.
Rodriquez works in front of thousands upon thousands of people each night who have paid, in some
cases, large sums of money to watch him play baseball. Businesses are willing to pay millions to
advertise their products in the stadium where Mr. Rodriquez works. Even more businesses are willing
to pay millions of dollars to advertise their products on television when Mr. Rodriquez appears in a
game. This means networks are willing to pay hundreds of millions if not billions of dollars to have
the right to show him and other players work.
When is the last time a kindergarten teacher taught in front of 40,000 screaming fans? How often
do cookie and milk companies pay huge sums to advertise in his or her classroom? Have you ever
seen a corporation pay millions to advertise on a televised presentation of his or her kindergarten
lectures? How many networks clamor to show the lessons he or she offers to the kids?
Because Alex Rodriquez generates far more revenue for his employer than any kindergarten
teacher, his value of the marginal product is far greater. The result? The intense competition from
profit-maximizing baseball team owners for "A-Rod's" services mean that over the next ten years Mr.
Rodriquez will be paid $252,000,000 to play baseball. A kindergarten teacher, making an average of
$25,000 per year would have to teach for 1,000 years to earn that much money.
Topic: Profit maximization
Skill: Level 5: Critical thinking
Objective: Checkpoint 18.2
Author: JC
12) How does a firm's demand for labor change if the price of the firm's product increases? Relate your answer
to the value of the marginal product.
Answer: An increase in the price of the firm's product increases the firm's demand for labor. The value of the
marginal product equals the marginal product multiplied by the price of the product. Hence an
increase in the price of the product increases the value of the marginal product and thereby increases
the demand for labor.
Topic: Demand for labor
Skill: Level 2: Using definitions
Objective: Checkpoint 18.2
Author: TS
13) The above table has the marginal product schedule for a firm. If the price of the product is $2 a unit,
complete the table. If the wage rate is $8 an hour, how many workers does the firm hire?
Answer:
If the wage rate is $8 an hour, the firm hires 4 workers because that is the quantity that sets the value
of the marginal product equal to the wage rate.
Topic: Value of marginal product
Skill: Level 4: Applying models
Objective: Checkpoint 18.2
Author: WM
14) The table above shows the total product schedule for Shines Car Wash. The market for car washes is
perfectly competitive and car washes sell for $5 each. The labor market is competitive and the wage rate is
$50 per day. What is the value of marginal product for each worker? How many workers does the firm hire
to maximize profit?
Answer:
The value of marginal product is the marginal product multiplied by the price of a car wash. The value
of marginal product schedule is given in the table above. To maximize its profit, when the wage rate is
$50 per day, Shines Car Wash hires 2 workers because at this point the value of marginal product
equals the wage rate.
Topic: Value of marginal product
Skill: Level 4: Applying models
Objective: Checkpoint 18.2
Author: CD
15) The above table has the marginal product schedule for Nick's Pizza.
a. If pizza sells for $8 each, complete the last column of the table.
b. If Nick can hire workers at the going wage rate of $16 an hour, how many workers does Nick hire?
Answer:
a. The completed table is above.
b. Nick hires 4 workers because that is the quantity of workers that sets the value of the marginal
product equal to the wage rate.
Topic: Value of marginal product
Skill: Level 4: Applying models
Objective: Checkpoint 18.2
Author: SA
16) Tom and Mary grow tomatoes. They can hire different numbers of college students to help plant, cultivate,
and harvest the tomatoes. The above table gives their marginal product schedule.
a. If the price of a pound of tomatoes is $2 a pound, complete the first value of the marginal product
column in the table. If Tom and Mary must pay their workers $10 an hour, how many workers do they hire?
b. If the price of a pound of tomatoes falls to $1 a pound, complete the second value of the marginal
product column in the table. If Tom and Mary still must pay their workers $10 an hour, how many workers
do they hire?
c. When the price of a pound of tomatoes falls, what happens to Tom and Mary's demand for labor curve?
Answer:
a. The completed table is above. Tom and Mary hire 4 workers because that is the number of
workers that sets the value of the marginal product equal to the wage rate.
b. The completed table is above. Tom and Mary hire 2 workers because that is the number of
workers that sets the value of the marginal product equal to the wage rate.
c. When the price of a pound of tomatoes falls, Tom and Mary's demand for labor decreases and
their demand for labor curve shifts leftward.
Topic: Value of marginal product
Skill: Level 4: Applying models
Objective: Checkpoint 18.2
Author: TS
17) A worker has a marginal product of 15 units a day, each of which can be sold for $10. Is it profitable to hire
this worker if the wage rate is $100 a day? Briefly explain your answer.
Answer: It is profitable to hire this worker because the worker's value of the marginal product is $150 a day (the
price, $10, times the marginal product, 15 units), which exceeds the wage rate of $100 a day. The
worker creates $150 more revenue for the firm at a cost of only $100. Hence it is profitable to hire this
worker.
Topic: Profit maximization
Skill: Level 2: Using definitions
Objective: Checkpoint 18.2
Author: TS
18) Is it possible for an individual to decrease the quantity of labor he or she supplies when the wage rate
increases? Briefly explain your answer.
Answer: Yes, it is possible for an individual to decrease the quantity of labor supplied when the wage rate
increases. A worker may do so if he or she values additional leisure time more than additional income,
and so the worker may decrease the quantity of labor he or she supplies. It is this reaction that leads to
the backward-bending labor supply curve, which shows that above a certain wage, as the wage rate
increases, the individual's quantity of labor supplied decreases.
Topic: Supply of labor
Skill: Level 2: Using definitions
Objective: Checkpoint 18.3
Author: SA
19) In order to spend more time with her children, a young mother decides to work less hours as her pay
increases. What does her labor supply curve look like?
Answer: The young mother's labor supply curve is backward bending. In other words, her labor supply curve
is positively sloped at lower wage rates, indicating that a higher wage rate increases the quantity of
labor she supplies. But when her wage rate reaches a certain amount, further increases in the wage
rate decrease the quantity of labor she supplies and her labor supply curve becomes negatively sloped.
Topic: Supply of labor
Skill: Level 2: Using definitions
Objective: Checkpoint 18.3
Author: JC
20) Explain why an individual's labor supply curve is backward bending.
Answer: An individual's labor supply curve bends backward when an increase in the wage rate decreases the
quantity of labor the worker supplies. The labor supply curve bends backwards because workers have
alternative uses for their time that they prefer to working. So if a worker is offered a high enough
wage rate, the worker figures that with the higher income from the higher wage rate, he or she can
afford to decrease the quantity of labor supplied in order to take additional time off from work to
enjoy more leisure time.
Topic: Supply of labor
Skill: Level 2: Using definitions
Objective: Checkpoint 18.3
Author: TS
21) As the population of Las Vegas increased, what happened to the supply of labor and the supply curve of
labor in Las Vegas?
Answer: As the population of Las Vegas increased, the supply of labor increased and the supply curve of labor
shifted rightward.
Topic: Supply of labor
Skill: Level 2: Using definitions
Objective: Checkpoint 18.3
Author: JC
22) What happens to the supply of labor when more people pursue education and training? Be sure to discuss
what happens to both the supply of low-skilled and high-skilled labor.
Answer: The supply of low-skilled labor decreases, and the supply curve of low-skilled labor shifts leftward.
Then, after people complete their training, the supply of high-skilled labor increases and the supply
curve of high-skilled labor shifts rightward.
Topic: Supply of labor
Skill: Level 2: Using definitions
Objective: Checkpoint 18.3
Author: PH
23) The Small Bookshop hires teenagers who love books. How does each of the following changes affect the
supply and demand for workers for the Small Bookshop?
a. The Big Bookshop, a chain bookstore down the street, offers a higher wage rate.
b. More people buy books from Amazon.com.
c. People watch more television and read fewer books.
d. More older people who love to read move into the area where the Small Bookshop is located.
Answer: a. The supply of workers for Small Bookshop decreases and the supply curve shifts leftward.
b. The demand for books from Small Bookshop decreases. The price of books at the Small Bookshop
falls and so the demand for workers decreases.
c. Similar to part (c), the demand for workers decreases.
d. An increase in the population of readers increases the demand for books and thus increase the
demand for workers at the Small Bookstore.
Topic: Demand and supply of labor
Skill: Level 2: Using definitions
Objective: Checkpoint 18.3
Author: SA
24) How does technological change affect jobs and wage rates?
Answer: Technological change creates and destroys jobs. On the average, it creates more jobs than it destroys
and the new jobs pay a higher wage rate than the old jobs that are destroyed.
Topic: Eye on the U.S. economy, reallocating labor
Skill: Level 3: Using models
Objective: Checkpoint 18.3
Author: WM
25) "Technological change destroys more jobs than it creates and thereby lowers average wages." Is the previous
statement correct or incorrect? Explain your answer.
Answer: The statement is incorrect on two counts. First, although the statement is correct that technological
change both creates and destroys jobs, on the average, it creates more jobs than it destroys. Second, on
the average, the new jobs created pay a higher wage rate than the old jobs destroyed and so
technological change contributes to raising average wages.
Topic: Eye on the U.S. economy, reallocating labor
Skill: Level 3: Using models
Objective: Checkpoint 18.3
Author: SB
26) The above figure represents the market for professional minor-league baseball umpires.
a. If umpires are offered $90 a game, what is the quantity of umpires supplied?
b. If umpires are offered $90 a game, is there a surplus or shortage of games umpired? What does the
shortage or surplus equal?
c. What is the equilibrium wage rate and quantity of umpires?
Answer: a. The quantity of umpires supplied is 20 umpires.
b. At $90 a game, there is a shortage of umpires. The shortage equals the quantity demanded, 50
umpires, minus the quantity supplied, 20 umpires, for a shortage of 30 umpires.
c. The equilibrium wage rate is $120 a game and the equilibrium quantity is 40 umpires.
Topic: Labor market equilibrium
Skill: Level 3: Using models
Objective: Checkpoint 18.3
Author: JC
27) The above figure represents the market for teenage workers at fast-food restaurants in Kansas City.
a. What is the equilibrium wage rate and employment?
b. Describe the market at a wage rate of $6 per hour.
c. Describe the market at a wage rate of $12 an hour.
d. How would an increase in the number of young, married college graduates, who tend to eat at fast-food
restaurants, affect the figure, the equilibrium wage rate, and employment?
Answer: a. The equilibrium wage rate is $8 an hour and the equilibrium quantity of employment is 4,000
workers.
b. If the wage rate is $6 an hour, the quantity of labor supplied is less than the quantity of labor
demanded. There is a shortage in the market.
c. If the wage rate is $12 an hour, the quantity of labor supplied is greater than the quantity of labor
demanded. There is a surplus in the market.
d. An increase in the number of people who eat in fast-food restaurants will increase the demand for
workers at fast-food restaurants. As a result the demand for labor curve will shift rightward and the
equilibrium wage rate and equilibrium quantity of employment will both increase.
Topic: Labor market equilibrium
Skill: Level 3: Using models
Objective: Checkpoint 18.3
Author: SB
28) What are the three factors that influence the supply of saving and shift the supply curve of saving? Briefly
explain how an increase in each affects the supply of saving.
Answer: The three factors are the population, average income, and expected future income. An increase in the
population increases saving. An increase in average income increases saving. And an increase in
expected future income decreases saving.
Topic: Supply of financial capital
Skill: Level 2: Using definitions
Objective: Checkpoint 18.4
Author: PH
29) What factors affect the demand for financial capital and the supply of financial capital? How does a change
in each affect the demand curve or the supply curve of capital?
Answer: Two main factors affect the demand for financial capital: population growth and technological change.
An increase in population increases the demand for financial capital and shifts the demand curve
for financial capital rightward. An advancement in technology increases the demand for some types of
capital and decreases the demand for others. On net, the demand for capital generally increases, and
so the demand for financial capital increases and the demand curve for financial capital shifts
rightward.
Three factors change the supply of financial capital: population, average income and expected
future income. An increase in population increases the number of savers, which increases saving and
shifts the supply curve of financial capital rightward. An increase in average income also increases
saving and shifts the supply curve of financial capital rightward. If expected future income is high
compared to a low current income, saving decreases and the supply curve of financial capital shifts
leftward.
Topic: Demand for financial capital, supply of financial capital
Skill: Level 3: Using models
Objective: Checkpoint 18.4
Author: CD
30) If the quantity of financial capital supplied exceeds the quantity of financial capital demanded, what takes
place?
Answer: If the quantity of financial capital supplied exceeds the quantity of financial capital demanded, the
interest rate falls in order to restore equilibrium. As the interest rate falls, the quantity of financial
capital supplied decreases and the quantity of financial capital demanded increases.
Topic: Financial market equilibrium
Skill: Level 2: Using definitions
Objective: Checkpoint 18.4
Author: JC
31) Sarah wants to open a flower shop and, in order to do so, needs to borrow from the financial markets. How
does each of the following events affect the interest rate she must pay?
a. People expect the economy to go into a recession, resulting in lower future incomes.
b. Average incomes rises.
c. The population increases.
Answer: a. With lower expected future income, people increase their saving. The supply of capital increases
and the interest rate falls.
b. When average incomes rise, people increase their saving. The supply of capital increases and the
interest rate falls.
c. An increase in the population affects both the demand for capital and the supply of capital. With
more people, the demand for capital increases as firms strive to meet the increased demand for goods
and services. This effect raises the interest rate. And, with more people, the supply of saving increases.
This effect lowers the interest rate. Because both the demand and supply increase, the net effect on the
interest rate is ambiguous.
Topic: Financial market equilibrium
Skill: Level 4: Applying models
Objective: Checkpoint 18.4
Author: SB
32) Kevin plans to open a used boat engine store. To do so, he needs $100,000 to buy engines and outfit the store.
Suppose Kevin has $20,000 in his saving account, which pays an interest rate of 5 percent per year. Further
suppose that the current interest rate for loans also is 5 percent per year. What is Kevin's opportunity cost for
the financial capital necessary to open the store? If the demand for financial capital decreases just when
Kevin plans to enter the financial capital market, what happens to his opportunity cost?
Answer: Kevin's opportunity cost is the interest he forgoes on his savings, 5 percent multiplied by $20,000, plus
the interest he pays on his loan, 5 percent of $80,000. So the opportunity cost of the financial capital
necessary to open the store is $5,000. If the demand for capital decreases, the interest rate falls. In this
case, Kevin's opportunity cost decreases.
Topic: Demand for financial capital
Skill: Level 3: Using models
Objective: Checkpoint 18.4
Author: CD
33) Discuss the difference between renewable and nonrenewable resources. Given an example of each.
Answer: A renewable natural resource can be used repeatedly; a nonrenewable natural resource can be used
only once, and once a particular unit is used, it cannot be used again. Forestland, cropland, rivers,
lakes, and wind power are examples of renewable natural resources. Examples of nonrenewable
resources include coal and oil.
Topic: Natural resources
Skill: Level 2: Using definitions
Objective: Checkpoint 18.5
Author: WM
34) What is economic rent? What factors can earn economic rent? In terms of a factor supply and demand
diagram, where is the economic rent located?
Answer: Economic rent is income received by any factor that is over and above the amount required to induce a
given quantity of the factor to be supplied. In other words, for a factor to be supplied, the income
received by the factor must at least meet the factor's opportunity cost. Any income above that amount
is economic rent. Any factor, not just land, can earn economic rent. In a supply and demand diagram,
economic rent is equal to the area above the supply curve and below the price of the factor.
Topic: Economic rent
Skill: Level 2: Using definitions
Objective: Checkpoint 18.5
Author: WM
35) Is economic rent equal to the opportunity cost of supplying land?
Answer: No, economic rent is not equal to the opportunity cost of supplying land. The opportunity cost of
supplying land (or, for that matter, any other resource) is the amount of income necessary to induce
the supply of a given quantity of a resource. Economic rent is income over and above the opportunity
cost.
Topic: Economic rent
Skill: Level 2: Using definitions
Objective: Checkpoint 18.5
Author: SA
36) Critics of the salaries of professional athletes contend that athletes would play for far lower salaries. How can
this statement be true?
Answer: The statement can be correct because a large fraction of the salaries of athletes is economic rent. Take
Michael Jordan for an example. Mr. Jordan has a degree in geography from the University of North
Carolina. If, while he was an NBA basketball player, the owners had revolted against rising salaries
and slashed his and all other players pay from millions per year to say $200,000 per year, Mr. Jordan
would have had to consider the opportunity cost of playing basketball at that pay. If his second-best
choice would have been to be a really tall geography teacher for $45,000 per year, chances are he
would have continued to play basketball at the lower pay rate. Therefore one can conclude that much
of what professional athletes make for their highly demanded and rare talents is economic rent.
Topic: Economic rent
Skill: Level 5: Critical thinking
Objective: Checkpoint 18.5
Author: JC
37) How do new technologies effect the price of nonrenewable resources?
Answer: New technologies have two general effects. First, new technologies that lead to the discovery of
previously unknown reserves of a nonrenewable natural resource increase supply, which decreases
the price of the resource. Second, new technologies that enable a more efficient use of a nonrenewable
resource decrease demand, and also lead to a decrease in the price.
Topic: Natural resources prices
Skill: Level 2: Using definitions
Objective: Checkpoint 18.5
Author: PH
38) Phil is an instructor who is paid $50,000 per academic year to teach four classes of principles of
microeconomics. One day, Phil tells his fellow instructors that he likes teaching so much, that he would be
willing to teach as long as the college paid him at least $23,500. How much, if any, economic rent does Phil
earns?
Answer: Economic rent is income that is over and above the opportunity cost of supplying a factor. The
opportunity cost of obtaining Phil to teach is $23,500 because at any lower income, he will do
something other than teach. Therefore Phil receives $50,000 - $23,500 = $26,500 of economic rent.
Topic: Economic rent
Skill: Level 3: Using models
Objective: Checkpoint 18.5
Author: TS