Problem 2. Compensating Wage Differentials: Income versus Paid Vacation

(20 points)

Imagine a labour market where workers care about only two aspects of their compensation

when choosing employers: wages and paid vacations.

Hint: this question is like the wage-safety problem.

Using a carefully labelled diagram, describe the relationship between wages paid by firms

offering longer paid vacations and those offering shorter vacations. In your diagram,

please assume there are three firms in the same industry but differ in their business

models and three workers that differ in their preferences. (5 points for diagram, 5 point for

explanation)

The government is considering imposing a requirement that all firms offer a minimum of

four weeks of paid vacation to their employees. Using neoclassical assumptions about

worker rationality and preferences, what impact will this regulation have on some of the

workers and firms? Please draw a separate diagram to illustrate this. What would happen

to wages? (5 points for diagram, 5 point for explanation