Problem Set 1: Fun with Supply and Demand!

All problems are due in class next week. Be complete and succinct. Feel free to work together, but submit your own answers.

1. Briefly analyze in terms of supply and demand the effects upon the given market of the following events. Are these changes a shift in the demand curve, a shift in the supply curve, a movement along the demand curve, or a movement along the supply curve? (More than one will apply. Be sure you understand why.) Explain briefly. Draw a graph.

a. 20,000 workers move from Michigan's Upper Peninsula to Wisconsin in order to take advantage of higher manufacturing wages in Wisconsin. (Discuss the effects in both labor markets, Michigan and Wisconsin. Think about why wages might initially be different in the two states. Hint: It is critically important that the migration is a response to a difference in wages.)

b. The deployment of troops from a particular military base reduces the local population by 10% overnight; within days 100 local barbers go out of business. (Discuss the local market for barbers.)

c. New regulations limit the amount of fish that can be caught off the coast of Maine, and 16 percent of professional fisherpersons wind up working in other industries.

2. Last year there were 5,000 paralegals working in Southeastern Wisconsin, and they earned an average wage of $15.50/hour. This year, there are 4,800 paralegals in the area with an average wage of $13.95/hour.

a. Based on this information, what do you think has changed-supply or demand? Explain briefly, using a graph.

b. Give a concrete explanation for why that may have happened, in terms of tangible changes in the world rather than economic jargon. (There are many possible answers.)

c. Does this information allow you to calculate the elasticity of demand for paralegals, the elasticity of supply, both, or neither? Calculate all you can.

d. Would you expect that the elasticity of supply is greater for paralegals or for patent lawyers? Why?

e. Would you expect that the elasticity of demand for paralegals is greater or less than that for patent lawyers? Why?

3. (Substantially harder, but worthwhile.) Suppose that there are currently no income taxes, but a tax of $4/hour is under consideration. (Note that this is a little different from how income taxes usually work-it is a fixed dollar amount per hour rather than a percentage of wages. It will be easier to work with this specification.) As it is, employers hire 250 billion hours of labor services per year at an average wage of $15/hour, but if the tax passes employment will be reduced to 225 billion hours per year and wages BEFORE taxes are assessed will rise to $18/hour.

a. If the tax passes, what will be the new wage net of the income tax?

b. How much revenue will the tax generate for the government?

c. Compute the elasticity of labor supply and labor demand. Sketch a graph to help you.

d. Compute the deadweight loss due to the tax. [Hint: Assume that the supply and demand curves are straight lines. The formula for the area of a triangle is Area = 0.5 x (base) x (height).]