Ch 26.Ch 26.Wage DeterminationWage Determination

A.A. Wage rateWage rateB.B. Nominal wageNominal wageC.C. Real wageReal wage

-- Wage rate: price paid per unit of labor services (one hour of work).-- Wage rate: price paid per unit of labor services (one hour of work).

* Labor earnings: multiply the wage rate by number of hours.* Labor earnings: multiply the wage rate by number of hours.

-- Nominal wage: amount of money received per hour, day, or year.-- Nominal wage: amount of money received per hour, day, or year.

-- Real wage: quantity of goods & services a worker can obtain with -- Real wage: quantity of goods & services a worker can obtain with nominal wages; reveals the “purchasing power” of nominal wages.nominal wages; reveals the “purchasing power” of nominal wages.

Real wages – adjusted for inflation.Nominal wages – not adjusted.

Labor Wages and Labor Wages and EarningsEarnings

GLOBAL PERSPECTIVE

Hourly Wages of Production WorkersSelected Nations Hourly Pay in U.S. Dollars, 2004

Source: U.S. Bureau of Labor Statistics, 2006

DenmarkGermany

SwitzerlandSweden

United KingdomFrance

United StatesAustralia

JapanCanada

ItalyKorea

TaiwanMexico

0 5 10 15 20 25 30 35

33.7532.53

30.2628.42

24.7123.89

23.1723.09

21.9021.4220.48

11.525.97

2.50

The Role of ProductivityThe Role of Productivity

The demand for labor is high in the U.S. and The demand for labor is high in the U.S. and other advanced economies because labor is other advanced economies because labor is productive due to: productive due to:

Plentiful capitalPlentiful capital Many natural Many natural

resourcesresources Advanced Advanced

technologytechnology Labor qualityLabor quality CultureCulture

-- Real wages in the U.S. in the long run have increased at about the same rate as increasesin output per worker.-- Increases in productivity result partly due to increased technology.

There’s a close There’s a close long- long- run relationship in run relationship in the U.S. between the U.S. between output per week and output per week and real hourly real hourly compensationcompensation (= (= wages & salaries + wages & salaries + employers’ employers’ contributions to social contributions to social insurance and private insurance and private benefit plans).benefit plans).

Graph shows Graph shows increases in labor increases in labor supply & labor supply & labor demand, resulting in a demand, resulting in a long-run, or secular, long-run, or secular, increase in wage rates increase in wage rates and employment.and employment.

Real Wages & Productivity

Real Wages and ProductivityReal Wages and Productivity Secular Growth of Real Secular Growth of Real

WagesWages Long Run Trend of Real Long Run Trend of Real

Wages in the U.S.Wages in the U.S.

Rea

l Wag

e R

ate

(Do

llars

)

Quantity of Labor

D1900

S1900

D1950

D2000D2020

S1950

S2000

S2020

D.D. Purely Competitive Labor Purely Competitive Labor MarketMarket1.1. MRP = MRC RuleMRP = MRC Rule

In this market:In this market: Firms compete Firms compete

for hiring specific for hiring specific labor.labor.

Qualified workers Qualified workers supply the labor.supply the labor.

Individual firms Individual firms and individual and individual workers are workers are “wage takers” “wage takers” since neither can since neither can exert any control exert any control over the market over the market wage rate.wage rate.

Now we look at specific wage rates(from ch. 25)

(S = MRC)

Total

wag

e co

st

Non-labor cost

Purely Competitive Purely Competitive Labor MarketLabor Market

Market Demand for LaborMarket Demand for Labor Market Supply for LaborMarket Supply for Labor Labor Market EquilibriumLabor Market Equilibrium MRP = MRC RuleMRP = MRC Rule

Graphically…Graphically…

Wag

e R

ate

(Do

llar

s)

Wag

e R

ate

(Do

llar

s)

($10)WC

($10)WC

Labor Market Individual Firm

Quantity of Labor Quantity of Labor

QC

(1000)

0 0

D=MRP(∑ mrps)

d=mrp

qC

(5)

s=MRC

S

e

c

b

a

Labor supply and labor demand in a (a) Labor supply and labor demand in a (a) purely competitive labor market and (b) purely competitive labor market and (b) a single competitive firm.a single competitive firm.

PC labor market has many firms competing in hiring a specific type of labor.PC labor market has many firms competing in hiring a specific type of labor. Each (numerous) qualified worker w/ identical skills supplies type of labor.Each (numerous) qualified worker w/ identical skills supplies type of labor. Individual firms and workers are ‘wage takers’ since neither can exert any Individual firms and workers are ‘wage takers’ since neither can exert any

control over the market wage rate. control over the market wage rate.

To produce, or not to produce…That is the question.

E.E. MonopsonyMonopsony1.1. Single buyer / employerSingle buyer / employer2.2. Firm is a “wage maker”Firm is a “wage maker”

MRC

b

a

c

●

In a Monopolistic Market:-- Employer’s marginal resource (labor) cost curve (MRC) lies above the labor supply curve S.-- MRP=MRC at point b.-- Monopolist hires Qb workers (compared with Qc under competition).-- Shown by point c on S, it pays only wage rate Wb (compared with the competitive wage Wc).

MRC curve is above the

S curve becausea higher wage is

needed toattract newworkers &for currentworkers.

Possible wage ratecould be between c and b.

Monopsony ModelMonopsony Model MonopsonyMonopsony Upward-Sloping Labor Upward-Sloping Labor

Supply to FirmSupply to Firm MRC Higher Than the MRC Higher Than the

Wage RateWage Rate Equilibrium Wage and Equilibrium Wage and

EmploymentEmploymentGraphically…Graphically…

Monopsony ModelMonopsony Model

Wag

e R

ate

(Do

llars

)

Quantity of Labor

0

S

MRP

MRC

c

b

aWc

Wm

Qm Qc

Examples of Monopsony Power

Monopsonistic Labor Market

Three Union ModelsThree Union Models 1) Demand Enhancement 1) Demand Enhancement

ModelModel Increase Product DemandIncrease Product Demand Increase ProductivityIncrease Productivity Alter the Price of Other InputsAlter the Price of Other Inputs

Wag

e R

ate

(Do

llar

s)

Quantity of Labor

Wu

Qc Qu

Wc

D1

D2

S

IncreaseIn Demand

Three Union ModelsThree Union Models 2) Exclusive or Craft Union 2) Exclusive or Craft Union

ModelModel Restricted ImmigrationRestricted Immigration Reduced Child LaborReduced Child Labor Encouraged Compulsory Encouraged Compulsory

RetirementRetirement Shorter Hour WorkweekShorter Hour Workweek Exclusive UnionismExclusive Unionism Occupational LicensingOccupational Licensing

Graphically…Graphically…

Three Union ModelsThree Union Models Exclusive or Craft Union Exclusive or Craft Union

ModelModelW

age

Rat

e (D

olla

rs)

Quantity of Labor

D

S1

Qc

Wc

S2

Wu

Qu

DecreaseIn Supply

Three Union ModelsThree Union Models 3) Inclusive or Industrial 3) Inclusive or Industrial

Union ModelUnion Model Inclusive UnionismInclusive Unionism

Wag

e R

ate

(Do

llars

)

Quantity of Labor

D

S

Qc

Wc

Wu

Qu Qe

a be

Overview of 4 Market Overview of 4 Market ModelsModels

Minimum WageMinimum Wage Minimum wage legislation is less likely to haveMinimum wage legislation is less likely to have an an

adverse effect in monopsonistic markets.adverse effect in monopsonistic markets. Critics of min. wage laws argue that it reduces Critics of min. wage laws argue that it reduces

employment.employment. If min. wage is set too high, some labor markets can If min. wage is set too high, some labor markets can

expect a surplus of labor.expect a surplus of labor. Increases in the Federal min. wage during the 1990s saw Increases in the Federal min. wage during the 1990s saw

smaller decreases in teenage employment than in smaller decreases in teenage employment than in previous min. wage hikes.previous min. wage hikes.

Unions support a higher min. wage because it makes Unions support a higher min. wage because it makes less-skilled workers less substitutable for union workers.less-skilled workers less substitutable for union workers.

Some supporters of the min. wage say it has a positive Some supporters of the min. wage say it has a positive employment effect due to reduced turnover rates, higher employment effect due to reduced turnover rates, higher efficiency, and therefore increased productivity.efficiency, and therefore increased productivity.

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

18-24 25-34 35-44 45-54 55-64 65+

Wage DifferentialsWage DifferentialsEducation Levels and Individual Annual Earnings

EducationalAttainment

An

nu

al E

arn

ing

s (T

ho

usa

nd

s o

f D

olla

rs)

Age

Professional Degree

Bachelor’s Degree

Associate’s Degree

High School Diploma

Wage DifferentialsWage DifferentialsAverage Annual Wages in Selected Average Annual Wages in Selected

Occupations, 2005 Occupations, 2005

SurgeonsAircraft PilotsPetroleum EngineersFinancial ManagersLaw ProfessorsChemical EngineersDental HygienistsRegistered NursesPolice OfficersElectriciansTravel AgentsBarbersRetail SalespersonsRecreation WorkersTeacher AidesFast Food Cooks

$177,690135,04097,35096,62095,57079,23060,62056,88047,27045,63037,75024,70023,17022,42021,10015,500

Source: Bureau of Labor Statistics, 2006

Occupation Annual Average Wages

Wage differentialscan arise from

both the demand-side & supply-sideof labor markets.

Annual work hours(2004)