- (Based on Chapter 6, Problem 1 of Benjamin et al., 2017). Ijeoma is considering a job with a firm that pays an annual salary of $20,000 and offers employees a compulsory benefit of three units of term life insurance (i.e. life insurance that pays out three times salary to the next of kin if the person dies). Ijeoma can purchase term life insurance for $3000 per unit in the insurance market. Ijeoma is currently unattached and is evaluating the compensation package offered by the firm. She incorrectly believes that she can choose fewer (or no) units of the life insurance and take the cash equivalent as salary if she elects to.
(a) Draw her budget constraint, with consumption on the vertical axis and units of insurance on the horizontal axis, under the assumption that each unit of term life insurance can be converted into the equivalent amount of cash. (b) Indicate her constrained choice, A, where she receives $20,000 in salary and three units of term insurance. Also indicate her preferred choice, B, where she receives one unit of life insurance. Is there any way she is better off with the constrained choice under the assumptions outlined above? (c) Suppose the firm is able to procur life insurance at a lower price than Ijeoma herself is able to in the insurance market. Draw the new budget line, assuming Ijeoma is able to forgo units of insurance for the cash equivalent, based on the price that the firm pays for insurance. Is it possible that the three compulsory units might now be optimal for Ijeoma? Why might the firm be able to procure insurance for Ijeoma at a lower cast than she herself is able to?
- (Based on Chapter 6, Problem 2 of Benjamin et al., 2017) Firms hire workers over a two-year planning horizon. The profit-maximizing employment rule in this case is
H +T +14,i+I+ r 1 =VMP,+1111P2, + r where H +T are hiring and training costs, r is the discount (interest) rate, VMP, is the expected value of the marginal value product of labour in year t, and W, is the wage rate in year t. Answer the following questions:
(a) How does this differ from the case where the firm faces no quasi-fixed costs (i.e. hiring and training costs) and can either hire workers at the going wage rate or fire workers without incurring costs (e.g. severance)? (b) What happens to employment in period 2 if VMP2 is lower than expected? (Hint: There are two possibilities. Outine both). (c) Suppose that VMP2 is again lower than expected in period 2, but anticipating the possibility of layoffs, the government imposes a layoff tax before the firm can respond. Further assume the imposition of the tax was not expected in period 1. What happens to employment now? (Hint: how does the tax affect the cost savings of reducing employment?)
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