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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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Lieberman & Hall; Introduction to Economics, 2005 3
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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Lieberman & Hall; Introduction to Economics, 2005 4
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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Lieberman & Hall; Introduction to Economics, 2005 5
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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Lieberman & Hall; Introduction to Economics, 2005 6
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
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Figure 2: A Competitive Labor Market
Number ofWorkers
HourlyWage
LD
$12
LS
10,000
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Lieberman & Hall; Introduction to Economics, 2005 8
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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Lieberman & Hall; Introduction to Economics, 2005 9
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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Lieberman & Hall; Introduction to Economics, 2005 10
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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Lieberman & Hall; Introduction to Economics, 2005 11
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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Lieberman & Hall; Introduction to Economics, 2005 12
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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Lieberman & Hall; Introduction to Economics, 2005 13
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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Lieberman & Hall; Introduction to Economics, 2005 14
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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Lieberman & Hall; Introduction to Economics, 2005 15
Nonmonetary Job Characteristics
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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Lieberman & Hall; Introduction to Economics, 2005 16
Nonmonetary Job Characteristics
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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Lieberman & Hall; Introduction to Economics, 2005 17
Nonmonetary Job Characteristics
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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Lieberman & Hall; Introduction to Economics, 2005 18
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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Lieberman & Hall; Introduction to Economics, 2005 19
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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Lieberman & Hall; Introduction to Economics, 2005 20
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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Lieberman & Hall; Introduction to Economics, 2005 21
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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Lieberman & Hall; Introduction to Economics, 2005 22
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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Lieberman & Hall; Introduction to Economics, 2005 23
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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Lieberman & Hall; Introduction to Economics, 2005 24
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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Lieberman & Hall; Introduction to Economics, 2005 25
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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Lieberman & Hall; Introduction to Economics, 2005 26
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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Lieberman & Hall; Introduction to Economics, 2005 27
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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Lieberman & Hall; Introduction to Economics, 2005 28
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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Lieberman & Hall; Introduction to Economics, 2005 29
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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Lieberman & Hall; Introduction to Economics, 2005 30
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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Lieberman & Hall; Introduction to Economics, 2005 31
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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Lieberman & Hall; Introduction to Economics, 2005 32
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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Lieberman & Hall; Introduction to Economics, 2005 33
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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Lieberman & Hall; Introduction to Economics, 2005 34
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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Lieberman & Hall; Introduction to Economics, 2005 35
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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Lieberman & Hall; Introduction to Economics, 2005 36
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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Lieberman & Hall; Introduction to Economics, 2005 37
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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Lieberman & Hall; Introduction to Economics, 2005 38
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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Lieberman & Hall; Introduction to Economics, 2005 39
Figure 7: Vicious Cycle ofDiscrimination
Current JobDiscrimination
Lower Wage
Lower HumanCapital
InvestmentUnemployment
Lower Skill LevelLess Job
Experience
Pre-marketDiscrimination
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Lieberman & Hall; Introduction to Economics, 2005 40
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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Lieberman & Hall; Introduction to Economics, 2005 41
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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Lieberman & Hall; Introduction to Economics, 2005 42
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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Lieberman & Hall; Introduction to Economics, 2005 43
Using The Theory: The Minimum Wage
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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Using The Theory: The Minimum Wage
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