Economics 713: Assignment 6-

Q1. Suppose a union and an employer start to negotiate on January 1, 1998 over wages to be paid for the year 1998. There will be 50 paid weeks in the year (the rest being unpaid vacation time). No work will be done until they reach an agreement.

The employer's net revenue, after paying all costs other than wages (including a normal return on capital), is $500 per worker per week. The workers can earn $240 per week if they leave this employer and go to work elsewhere.

While negotiations continue workers can collect $130 per week in unemployment benefits (this is a straight subsidy that does not have to be repaid). The employer has retained an expert negotiator who charges $200 per week per worker.

The negotiations proceed as follows. At the beginning of each week the employer's and the union's negotiators meet, and one side proposes a wage for the rest of the year. If this proposal is accepted work begins immediately. If not, the workers collect unemployment benefits for the week, the employer's negotiator is paid for the week, and nothing happens for the rest of the week; next week there is a new meeting and a new proposal. At the first meeting a coin is tossed to determine which side makes the proposal for that week. In subsequent meetings they take turns: first one side makes a proposal, then the following week the other side makes a proposal, and so on.

(a) How long will these negotiations take? What wage agreement will be reached?

(b) Find the Nash bargaining solution for this situation.

Q2. American Family Publishers regularly sends a mass mailing to millions of people inviting them to enter their sweepstakes, with prizes worth millions of dollars. The odds of winning depend on the number of entrants. Resolve the following riddle.

How could anyone be so foolish as to waste time and stamps entering such a competition, given that the odds of winning are minuscule?

If everyone is smart enough to figure this out, how could anyone be so dumb that they would not enter the competition?

Q3. Suppose that both shoes and computers are produced using two factors, skilled and unskilled labor. Both technologies are of the CES form, with the same elasticity of substitution between skilled and unskilled labor, but with different factor intensities.

Assuming that the two product prices are given, and that both products are produced in a competitive economy, show explicitly (and succinctly) how the factor prices are determined, given the product prices, the factor intensity parameters, and the elasticity of substitution.

Using your result, what explanations can you suggest for recent trends showing that skilled wages have risen while unskilled wages have fallen?