CHAPTER 5 Quasi-Fixed Labor Costs and Their Effects on Demand

In addition to the questions below, solve the following end of chapter problems:
Review questions 1-8; Problems 5, 6, 8.

1. Suppose that workers can go to firms without training and earn $20,000 per year for the remainder of
their work life (suppose that is 20 years). Assume a zero interest rate. Further, suppose that YUKON
provides firm specific training at a cost of $10,000 in the first year and the worker produces nothing during
that first year. The training will increase the worker's productivity to $21,000 in years 2-20.

a. If Yukon pays workers $20,000 per year for 20 years and can force workers to stay for the 20
years,should it hire and train more or less workers? why?

b. If Yukon cannot force workers to stay for the 20 years, how could it structure pay to increase the chance
that the worker will stay?

c. Why might employees be reluctant to accept the kind of pay system described in b?

d. If the training provided by Yukon was general instead of firm specific, how much could Yukon pay
the worker in period 1 if it is to break even on the worker and can't force the worker to stay? Explain.

2. Explain why workers with firm specific training would be less likely to be laid off when there is a down
turn in demand for the employer's product.
Multiple-Choice

1. A quasi-fixed cost of labor is a cost that

A) is expected to change over time.
B) is proportional to the number of hours worked.
C) is proportional to the number of workers hired.
D) is proportional to the amount of capital used.

2. Which of the following is definitely NOT a quasi-fixed cost of labor?

A) unemployment insurance
B) health insurance
C) overtime pay
D) vacation pay

3. An increase in quasi-fixed costs would probably lead to a(n) ________ in the number of employees
hired and a(n) _________ in the number of overtime hours worked.
A) increase; decrease
B) increase; increase
C) decrease; decrease
D) decrease; increase

4. A mandated increase in overtime pay is likely to

A) cause employers to reduce overtime hours and convert them into added employment.
B) directly reduce the quasi-fixed costs per worker.
C) lead to a reduction in employment if higher costs cause a large scale effect.
D) lead to a reduction in employment if those who work overtime and those who are unemployed are
perfect substitutes.

5. A mandated increase in overtime pay is likely to

A) raise the average costs of labor, even if all overtime hours were eliminated.
B) cause an increase in labor hours due to the scale effect.
C) cause employers to increase straight-time hourly wages to compensate (because of the "package"
agreed upon).
D) cause an increase in labor hours due to the substitution effect.

6. Use of temporary-help agencies

A) increases employees' costs associated with searching for and applying for available temporary
openings.
B) increases the quasi-fixed costs of hiring temporary workers.
C) is more common when firms can build up inventories.
D) requires employers to pay more per hour than if they hired the worker directly.

7. Legislation requiring employer-provided health insurance for part-time workers would probably
_________ the employment of part-time workers and ________ the overtime of full-time workers.
A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease
8. If a firm offers specific training to its workers, when the training is over,
A) workers will most likely be paid a wage that is equal to their marginal product.
B) workers will most likely be paid a wage that is greater than their marginal product, to compensate
for the training.
C) workers will most likely be paid a wage that is less than their marginal product.
D) workers will most likely be paid a wage that is less than their wage before training.

9. If reserve clauses were outlawed in major-league baseball,

A) major league teams would have less incentive to train minor league players.
B) minor league players would be paid more.
C) players in the major leagues would be paid less than their marginal product.
D) players in the major leagues would be paid more than their marginal product.

10. Workers with firm-specific training are ________ likely to be laid off than are workers with general
training because _______
A) more; they are paid less than workers with general training.
B) more; their wage is less than their marginal product.
C) less; they are paid less than workers with general training.
D) less; their wage is less than their marginal product.

11. Employment-at-will means that

A) employees have the right to be hired for any job they desire.
B) employees have the right to be hired at any job for which they are qualified.
C) employers must have a "just reason" to fire an employee.
D) both employees and employers have the right to terminate employment at any time, for any reason.

12. Policies which protect workers against "unjust dismissal " have been shown to cause
A) decreased employment levels and increased hour fluctuations.
B) increased employment levels and decreased hour fluctuations.
C) increased employment levels and increased hour fluctuations,
D) decreased employment levels and decreased hour fluctuations.

Table 5-1: Two-Period Training Model

W0 = wage in first period
W1 = wage in second period
MP0 = marginal product of labor in first period
MP1 = marginal product of labor in second period
MP* = marginal product of labor in other jobs
Z = cost of training
W* = market wage for firms offering single period jobs

13. A profit-maximizing firm which wants to provide firm-specific training to its workers will pay
________ in the training period and ________ after training is completed. (See Table 5-1 for
definitions of abbreviations.)
A) W*, W*
B) more than W*; more than W*
C) less than W*; less than MP1
D) more than MP*; more than MP*

14. A profit-maximizing firm which wants to train its workers during the first period CANNOT (see Table
5-1 for definitions of abbreviations)
A) equate the present value of the marginal product of labor to the present value of expenditures.
B) allow WO + Z - MP1 to be greater than zero.
C) allow W1 to be greater than MPl.
D) allow Z to be greater than WO.
15. The present value of a firm's earnings over two periods is equal to its earnings in the initial period plus
the ________ value of its earnings in the next period, and will _________ as the interest rate rises.
A) discounted; rise
B) discounted; fall
C) future; rise
D) future; fall

16. General training is usually paid for by

A) the employer.
B) the employee.
C) both the employer and the employee.
D) neither the employer nor the employee.

17. Specific training is paid for by

A) the employer.
B) the employee.
C) both the employer and the employee.
D) neither the employer nor the employee.

18. After general training, the employee's wage will be

A) equal to his or her marginal product of labor.
B) greater than his or her marginal product of labor, due to the training received.
C) less than his or her marginal product of labor, to pay for the cost of the training received.
D) either greater or less than his or her marginal product of labor.

19. During a recession, average labor productivity tends to decrease because output falls and
A) prices also fall.
B) workers with specific training are not laid off.
C) workers with general training are not laid off.
D) neither workers with general training nor workers with firm-specific training are laid off.

20. A firm could profitably pay for a worker's general training if

A) the worker could change jobs easily.
B) the worker was nearing retirement.
C) the training program would also serve as a screening device.
D) the training increased the quasi-fixed costs of hiring the worker.

21. The use of an internal labor market implies that

A) workers in lower-level jobs will become less motivated and less dependable.
B) workers at the firm have no firm-specific training.
C) most upper-level jobs will be filled by promoting current workers.
D) the firm relies exclusively on credentials.

22. All else equal, a firm will prefer to hire a worker who will
A) stay at the firm for a long period of time.
B) stay at the firm for a short period of time.
C) be willing to work only a limited number of hours.
D) acquire firm-specific training from another firm.

23. Statistical discrimination is

A) using statistics to judge the average characteristics of a group of workers.
B) judging one person according to a group to which he or she belongs.
C) using statistics in hiring.
D) firing people due to low average productivity.
24. In Japan workers receive ________ rates of formal training than in the United States and this leads to
________ quit rates.
A) higher; lower
B) higher; higher
C) lower; lower
D) lower; higher

25. Training costs

A) exclude opportunity costs of trainees' time.
B) arise mostly from out-of-classroom training.
C) exclude the opportunity cost of using capital equipment.
D) exclude opportunity costs of trainers' time.
Answers

MC answers: 1c, 2c, 3d, 4c, 5a, 6d, 7c, 8c, 9a, 10d, 11d, 12a, 13c, 14c, 15b, 16b, 17c, 18a, 19b, 20c, 21c,
22a, 23b, 24a, 25b.
 Answers to Even-Numbered Review Questions
2. Why do upward-sloping labor supply curves to firms cause the marginal expense of labor to
exceed the wage rate?
Answer: With upward-sloping labor supply curves, firms wanting to increase their number
of employees must increase the wage offers for both their added workers and their
existing workers. Thus, the marginal expense of labor exceeds wages paid to the
added workers.

4. “Minimum wage laws help low-wage workers because they simultaneously increase wages
and reduce the marginal expense of labor.” Analyze this statement.
Answer: This statement has two aspects. First, minimum wage laws can increase wages
and reduce the marginal expense of labor if the labor market is characterized by
monopsonistic conditions and the minimum wage increases are not “too large”
(that is, they do not impose a wage higher than the pre-existing marginal expense
of labor). Second, however, these changes can only help workers if the higher
wage bills faced by employers do not drive their employers out of business.

6. Workers in a certain job are trained by the company, and the company calculates that to
recoup
its investment costs the workers’ wages must be $5 per hour below their marginal
productivity. Suppose that after training, wages are set at $5 below marginal productivity,
but that developments
in the product market quickly (and permanently) reduce marginal productivity by $2 per
hour. If the company does not feel it can lower wages or employee benefits, how will its
employment level be affected in the short run? How will its employment level be affected in
the long run? Explain, being sure to define what you mean by short run and long run!
Answer: In the short run (that is, when training investments have already been concluded,
so all
that is variable is the employment levels of trained workers), marginal revenue
product
still exceeds wages by $3 per hour, so it is advantageous for the company to
continue employing workers it has already trained. The company is not making
back enough to
make the training a good investment, but making back $3 per hour is better than
laying off the workers and making back nothing! Thus, workers will not be laid
off.
In the long run (that is, when the company is deciding about investing in new
workers), the $3 payback per hour is not sufficient to justify the training
investment if wages remain as they are. Thus, the firm will not hire and train new
workers under the current circumstances. Employment will fall as the firm fails to
replace those who leave, and the decline in employment will eventually serve to
raise the marginal productivity of labor. The decline in employment will stop when
the marginal revenue product of labor is once again $5 greater than the wage rate.
8. The manager of a major league baseball team argues: “Even if I thought Player X was
washed up,
I couldn’t get rid of him. He’s in the third year of a four-year, $24 million deal. Our team is
in no position to eat the rest of his contract.” Analyze the manager’s reasoning using
economic theory.
Answer: The manager is ignoring the fact that the cost of the player will be $24 million
over the period whether the player is on the team or not. Teams are always better
off maximizing profits, even if they are losing money under their current
conditions, and the team may be able to generate more profits if it replaces Player
X. The condition for replacement is that the difference between the marginal
revenue product of the new player and that of Player X exceeds the salary of the
new player (the marginal expense of continuing Player X is zero).
 Answers to Even-Numbered Problems
6. Teddy’s Treats, the dog biscuit company in Problem 5, has the following marginal revenue
product of labor (MRPL):

Number of Hours MRPL

18 29
19 27
20 25
21 23
22 21

a. Add the marginal revenue product curve to the drawing in Problem 5.

b. If Teddy’s Treats is maximizing profits, how many hours of labor will be hired? What
wage
will be offered?

Answer: a.

b. The profit-maximizing number of hours is 20 and Teddy’s Treats will offer a

wage of $6 per hour.

8. Suppose the marginal expense of hiring another worker is $150 and the marginal expense of
hiring current workers for an extra hour is $10. The added output associated with an added
worker, holding both capital and average hours per worker constant, is 120. The added
output generated by increasing average hours per worker, holding capital and the number of
employees constant, is 7. If the firm is interested in maximizing profits, what should it do?
Answer: For profits to be maximized, the following condition must hold:
 MEM /MPM  MEH /MPH

With this firm, MEM /MPM  150/120  1.25 and MEH /MPH  10/7  1.43.
Since the cost of an added unit of output produced by hiring more workers is less
than the cost of an added unit of output produced by hiring workers for more
hours, the firm should hire more workers and have each worker work fewer hours.