Chapter 09_The Labor Market and Wage Rates.ppt

7/28/2019 Chapter 09_The Labor Market and Wage Rates.ppt

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Slides by John F. Hall

Animations by Anthony Zambelli

INTRODUCTION TO ECONOMICS 2e / LIEBERMAN & HALL

CHAPTER 9 / THE LABOR MARKET AND WAGE RATES

2005, South-Western/Thomson Learning

Chapter 9

The Labor Market and

Wage Rates


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Lieberman & Hall; Introduction to Economics, 2005 2

Labor Markets In Perspective

Labor Markets differ in an important way from the othermarkets weve considered so far in this book Firms need resources to make goods and services

We can identify three general categories of resourcemarkets Markets for capital

Markets for land

Markets for labor

Labor is different from other things that are traded

Sellers of labor care about factors in the work place Another feature of labor is the meaning of the price in this

market Wage rate


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Figure 1: Product and FactorMarkets

Households Firms

S

D

Demand for Goodsand Services

Supply of Goodsand Services

Demand forResources

Supply ofResources

Factor Markets

Product Markets

S

D


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Defining a Labor Market

How broadly or narrowly we define amarket depends on the specific questionswe wish to answer

Broadly defined markets may look at marketsthat draw on labor from all over the world

Narrowly defined markets may look at marketsthat draw on labor on a very localized level


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Competitive Labor Markets

Market with many indistinguishable sellersof labor and many buyers

Involves no barriers to entry or exit

Perfectly competitive labor markets mustsatisfy three conditions Great many buyers (firms) and sellers (households) of

labor in market

All workers in market appear the same to firms

No barriers to entering or leaving labor market


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Competitive Labor Markets and TheEquilibrium Wage

Wage rate determined like the price of other competitive markets: Supply and demand The labor demand curve in any labor market slopes downward because

a rise in the wage rate 1) increases firms costs, causing them to decrease production and employ

fewer workers

2) increases the relative cost of labor from that market, causing firms tosubstitute other inputs, such as capital or other types of labor

The labor supply curve in any labor market slopes upward because arise in the wage rate 1) induces some of those not currently working to seek work 2) attracts some of those who are currently working in other labor markets

The forces of supply and demand will drive a competitive labor market toits equilibrium pointthe point where the labor supply and labor demandcurves intersect


7/44Lieberman & Hall; Introduction to Economics, 2005 7

Figure 2: A Competitive Labor Market

Number ofWorkers

HourlyWage

LD

$12

LS

10,000


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Why Do Wages Differ?

Significant inequality exists in wageratesAmong different occupationsAmong and within occupations in U.S.labor market

Wage inequality is persistentBoth highest and lowest paid

occupations have been so for decades


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An Imaginary World

To understand why wages differ in the realworld, lets start by imagining an unreal world

Except for differences in wages, all jobs are

equally attractive to all workersAll workers are equally able to do any job

All labor markets are perfectly competitive

In such a world, we would expect everyworker to earn an identical wage in long-run


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An Imaginary World

Figure 3 shows two different labor marketsthat initially have different wage rates

In our imaginary world, could this diagram

describe long-run equilibrium in these markets? No

As these shifts occur, market wage rate of

elementary school teachers will rise and thatof systems analysts will fall


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Figure 3: Disappearing WageDifferentials

Number of ElementarySchool Teachers

HourlyWage

LD

20

A'

A

$25

Number of ComputerSystems Analysts

HourlyWage

LD

$30

B'

B

25

(a) (b)

S

1L

S

2L S

1L

S

2L


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An Imaginary World

When will the entry and exit stop? When there is no reason for an elementary school teacher to want to

be a systems analyst When both labor markets are paying same wage rate

Long-run adjustments will occur even if no one actually

switches jobs Changes will continue untilat points A and Bthe long-

run wage rate is equal in both markets

Take any one of these assumptions away, and equal-wage

result disappears Tells us where to look for sources of wage inequality in real world A violation of one or more of our assumptions


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Compensating Differentials

In our imaginary world, all jobs were equallyattractive to all workers

In real world, jobs differ in hundreds of ways thatmatter to workers

When one job is intrinsically more or less attractivethan another Can expect wages to differ by a compensating wage

differential

Difference in wage rates that makes two jobs equally attractive toworkers


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Nonmonetary Job Characteristics

When evaluating a career, whether you areaware of it or not, you are evaluatinghundreds of nonmonetary job characteristics,including

Risk of death or injury Cleanliness of work environment Prestige you can expect in your communityAmount of physical exertion required

Degree of intellectual stimulation Potential of advancement


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You will also think about geographic location of job andcharacteristics of the community in which you would live andwork Weather

Crime rates

Pollution levels

Transportation system

Cultural amenities

Nonmonetary characteristics of different jobs give rise to

compensating wage differentials Jobs considered intrinsically less attractive will tend to pay higher

wages, other things being equal


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What about unusually attractive jobs? These jobs will generally pay negative compensating

differentials

Different people have different tastes for working

and living conditions Cannot use our own preferences to declare a job

as less attractive or more attractive Or to decide which jobs should pay a positive or negative

compensating differential Rather, when labor markets are perfectly competitive

Entry and exit of workers automatically determines compensatingwage differential in each labor market


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Compensating wage differentials are one reasonmost economists are skeptical about idea ofcomparable worth

Holds that a government agency should determine skills

required to perform different jobs and mandate wagedifferences needed between them

Economists generally prefer policies to increasecompetition and eliminate discrimination

So that the market itself can determine comparable worth


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Cost of Living Differences

Differences in living costs can causecompensating wage differentials

Areas where living costs are higher than average

will tend to have higher than average wages To compensate for the higher cost of living


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Differences in Human CapitalRequirements

All else equal, jobs that require more education and training will be lessattractive In order to attract workers, these jobs must offer higher pay than other jobs

that are similar in other ways, but require less training

Differences in human capital requirements can give rise tocompensating wage differentials

Jobs that require more costly training will tend to pay higher wages, otherthings equal

Compensating differentials explain much of the wage differentialbetween jobs requiring college degrees and requiring only a high schooldiploma

The idea of compensating wage differentials dates back to Adam Smith First observed that unpleasant jobs seem to pay more than other jobs thatrequire similar skills and qualifications


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Differences In Ability

Not everyone has the intelligence needed to perform well atany job

Scientific discoveries and technological advances haveincreased not only skill requirements of many jobs

But also abilities needed to acquire those skills In general, those with greater ability to do a job wellbased

on their talent, intelligence, motivation, or perseverancewill be more valuable to firms Firms will be willing to pay them a higher wage rate

Beyond any compensating differential for their human capital investment


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The Economics of Superstars

Why was owner of Texas Rangers willing to pay $25 million per year tohave Alex Rodriguez play for his team?

Immediate answer

Because Rodriguez is so good

When we try to explain extremely high wage rates of these superstars

based on their exceptional abilities alone, we confront a puzzle The very top writers, rock stars, comedians, talk-show hosts, and movie

directors all earn wage premiums that seem vastly out of proportion totheir additional abilities

Why?

Explanation in all these cases is based on ability And also by exaggerated rewards market bestows on those deemed the

best or one of the best in a field


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The Economics of Superstars

If most people rank recent mystery novels in the sameorder, then the best will sell millions of copies, second bestwill sell hundreds of thousands, and third best might sellonly thousands Even though all three novels might be very close in quality

A publisher will earn ten times more revenue selling the bestnovel (compared to the second best), and ten times morerevenue selling the second best (compared to the thirdbest), and so on

Same thing happens in markets for athletes, rock concerts,action movies, and news broadcasters But phenomenon is not limited to media markets or media stars


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Barriers to Entry

In some labor markets, barriers keep out would-beentrants

Resulting in higher wages in those markets

Since barriers to entry help maintain high wages forthose protected by the barriersthose who alreadyhave jobs in the protected market

Should not be surprised to find that in almost all cases, it

is those already employed who are responsible forerecting barriers


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Occupational Licensing

In many labor markets, occupational licensing laws keep out potentialentrants

American Medical Association (AMA) is perhaps the strongest exampleof occupational licensing as a barrier to entry

Professional organization to which almost half of American physiciansbelong

Much of AMAs activity has been designed to decrease supply of doctors

AMA has also increased demand for physicians services by preventingnonphysicians from competing

In late 1980s, rising health care costs led to increased public scrutiny ofAMA, and its anticompetitive practices came under heavy attack

Economists see AMA primarily as an instrument to maintain highincomes for doctors


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Figure 4: The Market for Physicians

Number of Physicians

Physicians'Salaries

W1

W2

W3

C

B A

3. Other policies to

increase demandfor physiciansmove the markethere, at finalwage rate W3.

1. WithoutAMA activitiesto increase salaries,equilibrium is here, atwage rate W1.

2.AMA restrictionson the supplyofphysicians move

the market here.

S

1L

S

2L

D

2L

D

1L


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Union Wage Setting

A labor union represents collective interests of itsmembers Major objective of a union is to raise its members

pay Higher union wage is contrary to interests of employer

so why does employer agree? Because union has power to strike

In a competitive labor market, a unionby raisingthe wage firms must paydecreases total

employment in the union sector This, in turn, causes wages in non-union sector to drop Result is a wage differential between union and non-

union wages


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Figure 5(a): Union Wage Differentials

Number of Long-haul Truckers

Wage

LS

W1

W2

LD

A'

A

250,000

300,000

350,000

1. With no labor union, both long-and short-haul truckers earn the

same wage rate, W1.

2. A union wage of for long-haul truckers ofW2creates an excess supply of workers.

(a)


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Figure 5(b): Union Wage Differentials

Number of Short-haul Truckers

W3

W1 B'

B

LD

200,000

225,000

(b)

3. Unemployed long-haul truckers move to thenonunion short-haul market, and the laborsupply curve shifts rightward . . .

4. pushing the short-haul wage

rate down to W3.

Wage

S

1L

S

2L


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Union Wage Setting

Unions still maintain a significant, though declining,presence in many industries Such as automobiles, steel, coal, construction, mining, and trucking

Certainly responsible for at least some of the higher wages earned inthose industries

Full effect of unions on labor markets is much more complex

Many of the features of modern work that we take forgranted today originated in union struggles withmanagement

Such as paid vacations and overtime pay Unions can raise workers morale and reduce labor turnover

Through grievance procedures and other forms of communicationswith management


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Discrimination and Wages

Discrimination occurs when members of a group ofpeople have different opportunities because ofcharacteristics that have nothing to do with theirabilities

First step in understanding economics ofdiscrimination is to distinguish two words that areoften confused Prejudice

Emotional dislike for members of a certain group

Discrimination Restricted opportunities offered to such a group


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Employer Prejudice

When you think of job discrimination, your firstimage might be a manager who refuses to hiremembers of some group because of pure prejudice Such as African-Americans or women

May surprise you to learn that economists generallyconsider employer prejudice one of the leastimportant sources of labor market discrimination When prejudice originates with employers, market forces

work to discourage discrimination and reduce oreliminate any wage gap between favored and unfavoredgroup


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Employee and Customer Prejudice

What if workersrather than employersare prejudiced? In a competitive output market, non-discriminating firm will be forced

out of business

Cannot count on the market to solve the problem

Same argument applies if the prejudice originates with firms

customers When prejudice originates with firms employees or its

customers Market forces may encourage, rather than discourage, discrimination

Can lead to a permanent wage gap between favored and unfavoredgroups

Fi 6 E l Di i i ti d


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Figure 6: Employer Discrimination andWage Rates

Number of Workers

Wage

W1

W3

LD

Sector A(Discriminating)

Number of Workers

Wage

W2

W1

Sector B(Nondiscriminating)

LD

E

E'F

F'

S

1

LS

2L

S1L

S

2L


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Statistical Discrimination

Suppose you are in charge of hiring 10 new employees atyour firm Young married women in your industry are twice as likely to quit their

jobs within two years than men and those that quit are very costly toyour firm

20 people apply for 10 positionshalf men and half women Whom will you hire?

If your sole goal is to maximize the firms profit You will hire men

Even if there isnt a trace of prejudice in you, in the firms

employees, or in its customers, profit maximization may stilldictate hiring the men


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Statistical Discrimination

When individuals are excluded from an activitybased on the statistical probability of behavior intheir group

Rather than their personal characteristics

Some observers have suggested that statisticaldiscrimination is often a cover for prejudice

According to critics of the statistical discrimination

theory, the negative behavior of a favored group israrely considered by employers


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Dealing With Discrimination

Discrimination due to pure employer prejudice is unlikely tohave much of an impact on labor markets

For other types of discrimination market incentives work inthe opposite way, leading to a permanent and stubborn

problem Such as statistical discrimination or discrimination due to worker orconsumer prejudice

In these cases, many economists and other policy makers believe thatgovernment action is needed

Some favor affirmative action programs

Others favor stricter enforcement of existing antidiscrimination laws andstiffer penalties when discriminatory hiring occurs

Both approaches to policy force all firms to bear costs ofnondiscriminatory hiring


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Discrimination and Wage Differentials

Consider the black-white differential for men Several studies suggest that if we limit comparisons to whites and

blacks with same educational background, geographic location, and, insome cases, same ability (measured by a variety of different tests), 50%or more of the earnings difference disappears

In addition to job-market discrimination, there is pre-market

discrimination Occurs before an individual enters labor market

Such as unequal treatment in education and housing

For women, as well as blacks and other minorities, differences in skillsand experience can be the result of lower wages

Since women know they will earn less than men and will have more troubleadvancing on the job They have less incentive to invest in human capital and to stay in labor force


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Discrimination and Wage Differentials

In the end, we do not know nearly as much about the impactof discrimination on wages as we would like to know But research is proceeding at a rapid pace

As weve seen, data must always be interpreted with care In measuring impact of job market discrimination on earnings

Wage gap between two groups gives an overestimate Since it fails to account for differences in skills and experience

However, comparing only workers with similar skills and experienceleads to an underestimate

Since some of the differences are themselves caused bydiscriminationboth in the job market and outside of it

Figure 7: Vicious Cycle of


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Figure 7: Vicious Cycle ofDiscrimination

Current JobDiscrimination

Lower Wage

Lower HumanCapital

InvestmentUnemployment

Lower Skill LevelLess Job

Experience

Pre-marketDiscrimination


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Using The Theory: The Minimum Wage

Minimum wage lawmakes it illegal to hire aworker for less than a specified wage In any labor market covered by the law

Most people think about the minimum wage as a

means to increase living standards for the lowestpaid workers, and their analysis stops there

But minimum wage creates a wage differentialamong the least-skilled workers, depending on the

industry in which they work By raising wages rates in covered industries, and

lowering them in uncovered industries


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Figure 8(a/b): The Minimum Wage

Hourly

Wage

LD3.00

$4.00

(b)

Unskilled LaborNotCovered by Law

Number of Workers

Hourly

Wage

L

D4.00

$5.15LS

N2 N1 N3

(a)

Unskilled LaborCovered by Law

A'

A

B'B

A minimum wage raisespay, but decreases jobsin the covered sector.

Some who can'tfind work go tothe uncovered

sector, loweringwages there.

Number of Workers

S

1L

S

2L


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Figure 8(c): The Minimum Wage

Number of Workers

HourlyWage LS

20.00

$24.00

(c)

Skilled Labor

C'

C

As capital is substituted for

unskilled labor, demand forskilled workers goes up,raising the skilled wage rate.

D

2L

D

1L


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Only one group of workers in which everyonebenefits: skilled workers

Should come as no surprise that for many decades themost vocal advocates of raising the minimum wage have

been labor unions Membership is disproportionately made up of skilled workers

What do economists think about the minimumwage?

Most regard it as an inefficient policy for helping poorworking families


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You might think that economists wouldoverwhelmingly oppose any increase in minimumwage

But that is not the case

Those who favored an increase in minimum wage tended tobelieve the effect on unemployment was much smaller thanthose who opposed an increase

Others may believe that higher unemployment is more likely toinfluence policy in a direction they favor

The minimum wage, like most issues of publicpolicy, is not as simple as it appears

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Chapter 09_The Labor Market and Wage Rates.ppt