Labor Markets and Wage Rates

Supply of and Demand for Labor

“Economic Rent” and Wage Rates

Real Wages versus Money Wages

The Minimum Wage and the Living Wage

Demand and Supply of Labor

Obvious: Some people are paid more than others

• George Lucas -- $200 million• Oprah Winfrey -- $150 million• Steven Spielberg -- $100 million• Average American Worker -- $25-35 thousand

Primary Reason for disparity of income = Supply and Demand

The Supply of LaborNoncompeting Groups; Short-run vs Long-

Run In the short-run there are at least three categories or

strata of labor• Skilled Labor

Craftsmen Professional Other highly trained

• Semi Skilled Assembly line workers Supermarket checkers

• Unskilled Dishwashers General labor Strength versus think type work

The Supply of LaborNoncompeting Groups: Long-run

Opportunity for lesser trained to train for more skilled position

Higher paying jobs tend to attract more people who can then compete for those jobs

In the long run the categories tend to blur and Labor becomes quite mobile So, in the long run we are all competitors in

the same employment pool

The Supply of LaborTheory of the Dual Labor Market

A more radical, class theory of employment Primary Labor Market

• The Good jobs, such as• Professional positions• Management• Skilled technical

Secondary Labor Market• Not so good jobs Temporary• Low pay Little opportunity for advancement• Dead-end

The Rich stay rich and the poor stay poor

The Supply of LaborThe Backward-bending Labor Supply

Curve Begins with the concept that the higher the pay, the

more willing we are to substitute time at work for other activities

Who will work full time for $2/hour? Who will work full time for $40/hour? This is the substitution effect! As our pay is

increased, we are willing to spend more hours at work But there comes a time, when our incomes are

sufficient to meet our needs and we now begin to value leisure time and want to work less

This is called the income effect of labor supply

Hypothetical Labor Supply Curve

29-8Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

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40

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0

S

Hours worked per week

J

0 15 30 45 60 75 90

A person will be willing to work an increasing amount of hours per week as the hourly wage rate goes up. But a some point (point J in this instance) he or she will begin to cut back on the hours worked as the wage rate continues to rise.

Up to point J, work is substituted for leisure time (substitution effect)

Beyond point J the curve bends backward as the income effect outweighs the substitution effect and the person is willing to trade away some money for more leisure time

The Demand for Labor

Recall from Chapter 14, the demand for a factor is the Marginal Revenue Product (MRP) for that factor, where the MRP = the change in total revenue

the change in factor input

The demand curve for labor slopes downward to the right in conformance with the MRP calculation and the general law of demand

Determinants of Factor Demand

Demand for Final Products Manufactured from Resources (Factors) – Called “Derived Demand”

Productivity of the Factor

Prices of Substitute Factors

Hypothetical General Demand Curve for Labor

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0

Hours worked per week (millions)*

D

0 10 20 30 40 50 60 70 80

This is the sum of every firm’s MRP curve. As the wage rate is lowered, increasing quantities of labor are demanded

Hypothetical General Demand and Supply for Labor

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Hours worked per week (millions)*10 20 30 40 50 60 70 80

The wage rate is set by the intersection of the general demand and supply curves for labor. In this case the wage rate is about $16 an hour

How much would the actual wage rate be? A lot lower? In many cases, yes. It all depends on the type of work you do and on the demand and supply schedules in each of hundreds, or even thousands of job markets

Reasons for Pay Differentials

Supply/Demand factors in specific job markets Productivity from industry to industry Job content Industry profitability Culture and tradition “Winner take all markets”

High Wages and Economic Rent

Some people are paid extremely well for what they do

• Professional Sports• Movies• Television personalities

How Come? • Special abilities• High visibility• Supply of one

High Wages and Economic Rent

Whenever someone is paid more than he/she would be willing to work for, the difference is called “economic rent”

Text example: David Letterman makes $30 million/year

If Mr. Letterman would be willing to work for $5 million/year, the difference of $25 million is called economic rent

Still, it all boils down to Supply and Demand

High Wage Rates and Economic Rents

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Quantity0 1 2

D

S

Economicrent

Determination of Economic Rent by Supply and Demand

How much of David Letterman’s earnings are economic rent? If his earnings of $30 million are set by supply and demand, then his economic rent would depend on the minimum wage he would be willing to accept. If that were $5 million, then his economic rent would be $25 million

When ever a person gets paid more than the minimum she would be willing to accept, we call the excess economic rent.

Winner Take All Markets

American CEO’s earn on average about 500 times the salary of the average production worker

In Japan and Europe, CEO salaries much, much lower than in the U.S. Why?

CEO’s in the U.S. appear to be far more mobile than in Japan and Europe and therefore have been able to create a very inelastic supply curve where a few top performers walk away with the lion’s share of the total rewards

Also applies to professional sports, entertainment And is now impacting law, journalism, consulting, design,

fashion, etc. Diverting young talent into competition where most will lose

Real Wages versus Money Wages

By real wages, economists mean what you can actually buy with your wages

Inflation will erode a person’s purchasing power So, the important question is “what can you buy

with your money?” not “How much money are you making?”

Real wages measures the purchasing power of your income

Real Wages = Money Wages x 100 CPI (current Year)

Index of Real Wages, 1975-2001 (Base: Second Quarter of 1989 = 100)

29-28Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

The real wage now is below the level in the late 1970s

Declining Real Wages, 1973-1997

Never before in our history have real wages fallen over such an extended period of time

Period marked by five recessions Yet, Real GDP more than doubled

Why did real wages fall? and Productivity decline from late 1970’s thru mid 1990’s U.S. manufacturing outsourced production to Mexico,

Japan, Southeast Asia and China Switch from manufacturing to service industries

How did Americans maintain their standards of living? Continuing trend to two income households

Barely Getting By?

Beth Schulman – authored a book entitled The Betrayal of Work, 2003

Elizabeth Warren and Amelia Warren TyagiThe Two Income Trap, 2003

• Two income families worse off than their one income counterparts were in the 1970’s

• Middle class eroding and working poor are hurting• An opulent lifestyle of some is subsidized by low

wage work of millions• Perhaps law should mandate higher wages even if it

meant higher prices??

Minimum Wage; Living Wage

Minimum Wage – A price floor will cause a surplus of workers, ie. Unemployment & therefore

Minimum wage law hurts the very people it is supposed to help

Historical record is sporadic and would tend to indicate that other economic factors may outweigh the impact of present day minimum wage laws

Also, minimum wage increases have not kept pace with inflation – “real” minimum wage has fallen almost 40% since 1998

The Living Wage

Similar to a minimum wage but set higher to provide a “living wage”

Usually applied to contractors doing business with major municipalities New York City Los AngelesMinneapolisBoston Baltimore DenverCincinnati Chicago San Francisco

Studies show that unemployment slightly affected, but poverty rates have been moderately reduced

A Summing Up

Will employment of unskilled and inexperienced workers rise if we eliminate the minimum wage?

Yes. But the question is by how much It will rise very little if the demand for labor is very

elastic There is no question that teenagers, particular

nonwhite teenagers are the last hired and the most poorly paid

Is this because they are relatively unskilled and inexperienced?

Is this because they are discriminated against? Are older workers really more productive? Would teenagers work for lower than minimum wage?

29-36Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.