Question

Suppose that the labor supply of party clowns in Moscow is given by: w = 10 + 0.2QS. The labor demand in the market is described by: w = 40 – 0.2QD. In these equations, w represents the hourly wage, and Q represents the quantity of clowns.

a. (4 points) Assuming this is a competitive labor market, solve for equilibrium in the market. Sketch a simple diagram of the market, label the welfare areas, and solve for the welfare (surplus) calculations.

b. (3 points) Suppose that a recent epidemic of “creepy clown” sightings on the Palouse causes people to reduce their hiring of legitimate (though equally creepy) clowns as entertainment for their parties. With the aid of diagrams, discuss what you expect will happen to the equilibrium outcomes in the market. How is this likely to affect worker surplus, firm surplus, and total surplus when the market settles into a new equilibrium? What has happened to market efficiency after this change?

c. (5 points) (Ignore part b - suppose the market is in equilibrium from part a). In a shocking move, the Moscow City Council implements a minimum wage of $28 per hour for all mirth-based entertainers. I would love to tell you that this was the result of a grassroots social movement that rallied public support behind these glorious merrymakers and their noble quest to earn a living wage. Instead, sadly, I must report that this came about because one particularly charismatic clown, Chester McChuckles, personally extorted each member of the City Council.

- Determine what will happen to the number of clowns hired in this (competitive) market with the new minimum wage ($28).

- Draw a graph depicting the labor market situation with this minimum wage, and label the new areas of firm surplus and worker surplus

- Solve for the values of firm surplus, worker surplus, and total surplus

- Discuss the changes in welfare that occur after the wage change. Is the market operating efficiently?

d. (4 points) Use the two outcomes – the equilibrium from part a and the reaction to the minimum wage in part c – to calculate the elasticity of labor demand for party clowns in Moscow. Give a practical interpretation of your result. Then discuss whether this result matches your expectation based on our discussion of the Marshallian rules of derived demand.

Answer 1