Question 1:

a) What are the two main assumptions underlying the "neoclassical" theory of a short-run labor demand curve that is declining in rising wage rates (i.e., the "Law of Demand")?

b) Suppose there is a firm with two inputs of production, labor (L) and capital (K), with associated prices w and r, respectively.

Also assume that the firm faces competitive input and product markets and that the two inputs are gross complements in production. Show graphically the long-run labor demand as the wage increases. What happens to long-run demand for capital? Be sure to show the scale and substitution effects of a wage increase on the demands for labor and capital.

Question 2:

a) What are the Marshall's Rules of Derived Demand for labor?

b) The North American Free Trade Agreement (NAFTA) - which came into force on January 1, 1994 - created a trilateral trade bloc between the United States, Canada and Mexico. One result of the agreement was the elimination of U.S. tariffs on textile imports from Mexico. How would the elasticity of demand for labor in the U.S. textile industry been affected by this? Explain using relevant Marshall's Rules.

c) The U.S. Environmental Protection Agency (EPA) announced that greenhouse gases (GHGs) threaten the public health and welfare of the American people, as they are the primary driver of climate change. As a result, the EPA plans to set limits on allowable carbon dioxide (CO2) emissions and require the installation of pollution abatement technology (i.e., machine) in plants emitting CO2. Since fossil fuel industries (oil and coal) are among the biggest sources of CO2 emissions, how might these new regulations affect the elasticity of the labor demand in these industries? Explain using relevant Marshall's Rules.

Question 3:

a) What is a counterfactual, and what is the fundamental problem of causal inference? How does random assignment of a treatment address this problem?

b) Describe David Freedman's views on whether applying econometric techniques (e.g., regression analysis) to non-experimental (social science) data adequately addresses this problem. Include Freedman's views on the role of "research design" and discuss how John Snow's "cholera" study fits into Freedman's critique of the overuse of statistical techniques in the social sciences. 2

Question 4:

a) According to the neoclassical view of labor markets, what is the likely effect of an increase in the federal minimum wage on the employment of low-wage workers? Describe and show graphically. What happens to the aggregate earnings of low-wage workers if the elasticity of the labor demand curve is greater than one in absolute value?

b) Describe briefly two empirical studies covered in class that examine the effects of minimum wage changes on the employment of low-wage workers. In your description, include the empirical methods (i.e., treatment and control groups) and the main findings of each study. Is this evidence consistent with the predictions of the neoclassical labor demand theory?

c) Suppose the governor of Ohio is considering raising the minimum wage and wants to forecast the effect of this increase on the employment of restaurant workers. To predict the employment effects, the governor's analysts have applied a "difference-in-differences" approach utilizing the fact that Ohio increased the minimum wage from $7.00 to $7.30 on January 1, 2009, while Pennsylvania's minimum wage did not change on January 1, 2009. From the estimation of changes in the employment of low-wage workers in Ohio from April 2008 to April 2009 relative to the changes in Pennsylvania during the same time period, they concluded that the minimum wage increase will cause a reduction in the employment of low-wage workers in Ohio. Explain under what conditions this difference-in-differences approach can be used to estimate the causal effect of the minimum wage increase on employment