ECON 4531, Labor Economics

Text: Labor Economics, Borjas, 8th edition

1.Suppose there are two types of workers, type 1 and type 2. Their preferences are identical and represented by U(w,b) = 0.9 log(w) + log(b), where w is the wage and b is health benefits. Type 1 workers are more productive, however, and hence the two types face different job offers. Let w1(b) denote wages available to type 1 workers as a function of b and w2(b) denote wages available to type 2 workers as a function of b, where

w1(b) = 120-b

w2(b) = 100-b

(a) Is w1 increasing, decreasing or constant in b? Is this consistent with the theory of compensating wage differentials? Explain why or why not. How about w2?

(b) What is type 1's optimal choice of w and b?

(c) What is type 2's optimal choice of w and b?

(d) If you look at your solutions to parts (b) and (c), what is the sign of the correlation between wages and benefits? Is this consistent with the theory of compensating wage differentials? Explain why or why not.