Slides by John F. Hall Animations by Anthony Zambelli INTRODUCTION TO ECONOMICS 2e / LIEBERMAN &...

Slides by John F. Hall

Animations by Anthony ZambelliINTRODUCTION TO ECONOMICS 2e / LIEBERMAN & HALLCHAPTER 9 / THE LABOR MARKET AND WAGE RATES ©2005, South-Western/Thomson Learning

Chapter 9

The Labor Market and Wage Rates

Lieberman & Hall; Introduction to Economics, 2005 2

Labor Markets In Perspective Labor Markets differ in an important way from the other

markets we’ve considered so far in this book Firms need resources to make goods and services

We can identify three general categories of resource markets 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


Figure 1: Product and Factor Markets

Households Firms

S

D

Demand for Goodsand Services

Supply of Goodsand Services

Demand forResources

Supply of Resources

Factor Markets

Product Markets

S

D


Defining a Labor Market How broadly or narrowly we define a

market depends on the specific questions we wish to answer Broadly defined markets may look at markets

that draw on labor from all over the world Narrowly defined markets may look at markets

that draw on labor on a very localized level


Competitive Labor Markets Market with many indistinguishable sellers

of labor and many buyers

Involves no barriers to entry or exit Perfectly competitive labor markets must

satisfy 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


Competitive Labor Markets and The Equilibrium 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 to

substitute other inputs, such as capital or other types of labor The labor supply curve in any labor market slopes upward because a

rise 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 to its equilibrium point—the point where the labor supply and labor demand curves intersect


Figure 2: A Competitive Labor Market

Number of Workers

HourlyWage

LD

$12

LS

10,000


Why Do Wages Differ? Significant inequality exists in wage

rates Among different occupationsAmong and within occupations in U.S.

labor market Wage inequality is persistent Both highest and lowest paid

occupations have been so for decades


An Imaginary World

To understand why wages differ in the real world, let’s start by imagining an unreal world Except for differences in wages, all jobs are

equally attractive to all workers All workers are equally able to do any job All labor markets are perfectly competitive

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


An Imaginary World

Figure 3 shows two different labor markets that 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 that of systems analysts will fall


Figure 3: Disappearing Wage Differentials

Number of Elementary School Teachers

HourlyWage

LD

20

A'

A

$25

Number of Computer Systems Analysts

HourlyWage

LD

$30

B'

B

25

(a) (b)

S1L

S2L S

1LS2L


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 until—at points A’ and B’—the 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


Compensating Differentials In our imaginary world, all jobs were equally

attractive to all workers In real world, jobs differ in hundreds of ways that

matter to workers When one job is intrinsically more or less attractive

than another Can expect wages to differ by a compensating wage

differential• Difference in wage rates that makes two jobs equally attractive to

workers


Nonmonetary Job Characteristics

When evaluating a career, whether you are aware of it or not, you are evaluating hundreds of nonmonetary job characteristics, including Risk of death or injury Cleanliness of work environment Prestige you can expect in your community Amount of physical exertion required Degree of intellectual stimulation Potential of advancement



You will also think about geographic location of job and characteristics of the community in which you would live and work 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



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 compensating wage differential in each labor market



Compensating wage differentials are one reason most economists are skeptical about idea of comparable worth Holds that a government agency should determine skills

required to perform different jobs and mandate wage differences needed between them

Economists generally prefer policies to increase competition and eliminate discrimination So that the market itself can determine comparable worth


Cost of Living Differences

Differences in living costs can cause compensating 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


Differences in Human Capital Requirements

All else equal, jobs that require more education and training will be less attractive 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 to

compensating wage differentials Jobs that require more costly training will tend to pay higher wages, other

things equal Compensating differentials explain much of the wage differential

between jobs requiring college degrees and requiring only a high school diploma

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

require similar skills and qualifications


Differences In Ability Not everyone has the intelligence needed to perform well at

any job Scientific discoveries and technological advances have

increased 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 well—based on their talent, intelligence, motivation, or perseverance—will 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


The Economics of Superstars Why was owner of Texas Rangers willing to pay $25 million per year to

have 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 to their 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


The Economics of Superstars

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

A publisher will earn ten times more revenue selling the best novel (compared to the second best), and ten times more revenue selling the second best (compared to the third best), 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


Barriers to Entry

In some labor markets, barriers keep out would-be entrants Resulting in higher wages in those markets

Since barriers to entry help maintain high wages for those protected by the barriers—those who already have jobs in the protected market Should not be surprised to find that in almost all cases, it

is those already employed who are responsible for erecting barriers


Occupational Licensing In many labor markets, occupational licensing laws keep out potential

entrants American Medical Association (AMA) is perhaps the strongest example

of occupational licensing as a barrier to entry Professional organization to which almost half of American physicians

belong Much of AMA’s activity has been designed to decrease supply of doctors AMA has also increased demand for physicians’ services by preventing

nonphysicians from competing In late 1980’s, rising health care costs led to increased public scrutiny of

AMA, and its anticompetitive practices came under heavy attack Economists see AMA primarily as an instrument to maintain high

incomes for doctors


Figure 4: The Market for Physicians

Number of Physicians

Physicians'Salaries

W1

W2

W3

C

B A

3. Other policies to increase demand for physicians move the market here, at final wage rate W3.

1. Without AMA activities to increase salaries, equilibrium is here, at wage rate W1.

2. AMA restrictions on the supply of physicians move the market here.

S1L

S2L

D2L

D1L


Union Wage Setting A labor union represents collective interests of its

members 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 union—by raising the wage firms must pay—decreases 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


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 of W2 creates an excess supply of workers.

(a)


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 the nonunion short-haul market, and the labor supply curve shifts rightward . . .

4. pushing the short-haul wage rate down to W3.

Wage

S1L

S2L


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 in

those industries Full effect of unions on labor markets is much more complex Many of the features of modern work that we take for

granted today originated in union struggles with management Such as paid vacations and overtime pay

Unions can raise workers morale and reduce labor turnover Through grievance procedures and other forms of communications

with management


Discrimination and Wages Discrimination occurs when members of a group of

people have different opportunities because of characteristics that have nothing to do with their abilities

First step in understanding economics of discrimination is to distinguish two words that are often confused Prejudice

• Emotional dislike for members of a certain group

Discrimination • Restricted opportunities offered to such a group


Employer Prejudice

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

May surprise you to learn that economists generally consider employer prejudice one of the least important sources of labor market discrimination When prejudice originates with employers, market forces

work to discourage discrimination and reduce or eliminate any wage gap between favored and unfavored group


Employee and Customer Prejudice

What if workers—rather than employers—are 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 firm’s customers

When prejudice originates with firm’s employees or its customers Market forces may encourage, rather than discourage, discrimination

• Can lead to a permanent wage gap between favored and unfavored groups


Figure 6: Employer Discrimination and Wage 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'

S1L

S2L

S1L

S2L


Statistical Discrimination Suppose you are in charge of hiring 10 new employees at

your 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 to your firm

20 people apply for 10 positions—half men and half women• Whom will you hire?

If your sole goal is to maximize the firm’s profit You will hire men

Even if there isn’t a trace of prejudice in you, in the firm’s employees, or in its customers, profit maximization may still dictate hiring the men


Statistical Discrimination

When individuals are excluded from an activity based on the statistical probability of behavior in their group Rather than their personal characteristics

Some observers have suggested that statistical discrimination is often a cover for prejudice

According to critics of the statistical discrimination theory, the negative behavior of a favored group is rarely considered by employers


Dealing With Discrimination Discrimination due to pure employer prejudice is unlikely to

have much of an impact on labor markets For other types of discrimination market incentives work in

the opposite way, leading to a permanent and stubborn problem Such as statistical discrimination or discrimination due to worker or

consumer prejudice• In these cases, many economists and other policy makers believe that

government action is needed Some favor affirmative action programs Others favor stricter enforcement of existing antidiscrimination laws and

stiffer penalties when discriminatory hiring occurs Both approaches to policy force all firms to bear costs of

nondiscriminatory hiring


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, in some 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 skills

and experience can be the result of lower wages Since women know they will earn less than men and will have more trouble

advancing on the job• They have less incentive to invest in human capital and to stay in labor force


Discrimination and Wage Differentials

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

As we’ve 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 experience leads to an underestimate

• Since some of the differences are themselves caused by discrimination—both in the job market and outside of it


Figure 7: Vicious Cycle of Discrimination

Current Job Discrimination Lower Wage

Lower Human Capital

InvestmentUnemployment

Lower Skill LevelLess Job

Experience

Pre-market Discrimination


Using The Theory: The Minimum Wage

Minimum wage law…makes it illegal to hire a worker 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 lowest paid workers, and their analysis stops there

But minimum wage creates a wage differential among 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


Figure 8(a/b): The Minimum Wage

HourlyWage

LD3.00$4.00

(b)

Unskilled Labor Not Covered by Law

Number of Workers

HourlyWage

LD4.00

$5.15LS

N2 N1 N3

(a)

Unskilled Labor Covered by Law

A'

AB'B

A minimum wage raises pay, but decreases jobs in the covered sector.

Some who can't find work go to the uncovered sector, lowering wages there.

Number of Workers

S1L

S2L


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 for skilled workers goes up, raising the skilled wage rate.

D2L

D1L



Only one group of workers in which everyone benefits: skilled workers Should come as no surprise that for many decades the

most 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 minimum wage? Most regard it as an inefficient policy for helping poor

working families



You might think that economists would overwhelmingly oppose any increase in minimum wage But that is not the case

• Those who favored an increase in minimum wage tended to believe the effect on unemployment was much smaller than those who opposed an increase

• Others may believe that higher unemployment is more likely to influence policy in a direction they favor

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

Slides by John F. Hall Animations by Anthony Zambelli INTRODUCTION TO ECONOMICS 2e / LIEBERMAN &...

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