Question

intermediate Microeconomics ! 400 words for each question

(i) If water is needed to survive and diamonds are simply for jewelry, explain why diamonds are so expensive and water is so inexpensive?

(ii) How do minimum wages affect employment, and unemployment? In a competitive labor market, the demand for workers is given as QD=10,000-100W, and the supply of workers is given as QS=2,000+1,900W, where Q is the quantity
of workers employed and W is the hourly wage. What is the initial equilibrium wage and employment level? Suppose that the government decides that $5 per hour is the minimum allowable wage in any market. How would this new minimum wage alter this market? What would the new employment level be? What would happen to total payments to labor? Would there be any excess supply of labor?

Answer 1

1) Prices of diamonds are a reflection of both the marginal cost of production of diamond and the marginal willingness to pay that the consumers place on the diamond. Now, the cost of production of diamonds is huge. This makes the price that the producers ask for it very high. Water, on the other hand, is easily filtered so the cost of production is low. Accordingly, price of water is low.

While calculating willingness to pay for a commodity, consumers take into account the marginal benefit that the diamond would yield. The marginal benefit, in turn will depend upon how many units of the commodity the consumer already has. Think of it this way: if you are hungry, then one burger will give you a higher marginal benefit (accordingly you will be willing to pay for it more) than one more burger after you already had 4 burgers (accordingly, you will be willing to pay very less for the fifth burger, probably even fail to purchase it). Similarly, diamonds are rare, hence the consumers value having one diamond very highly because the marginal benefit that they receive from having diamond is huge. Water, on the other hand, is plentiful. So, the marginal benefit of having one cup of water is valued low. Therefore, diamonds are expensive whereas water, even though being life-saving is not.

2) Without the minimum wage, equilibrium occurs where the labor supply and labor demand intersects,

QD=QS

10,000-100W=2,000+1,900W

8,000 = 2,000W

W=$4

Therefore, the equilibrium wage rate is $4 per hour and at this wage rate, amount of labor supplied = labor demanded = 10,000 - 100*4 = 9,600

Now the government imposes a minimum wage of $5 per hour. This makes the new wage rate = $5. At wage rate = $5

amount of labor supplied = 2,000+1,900 * 5 = 11,500

amount of labor demanded = 10,000-100*5 = 9,500

New employment level =9,500.

Total payments to labor before minimum wage = labor employed*wage rate = 9,600*$4= $38,400

Total payments to labor after minimum wage = labor employed*wage rate = 9,500*$5= $47,500

Total payments to labor after minimum wage would increase from $38,400 to $47,500.

Since supply of labor demanded (11,500) is greater than the demand for labor (9,500), there will be excess supply of labor = (11,500-9,500) 2000 units.