Chapter 29: Labor Markets and Wage Rates

Chapter Objectives The supply of labor The demand for labor High wage rates and economic rent Real wages and productivity The minimum wage dispute

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Chapter 29Labor Markets and Wage Rates29-1Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Chapter ObjectivesThe supply of laborThe demand for laborHigh wage rates and economic rentReal wages and productivityThe minimum wage dispute29-2Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Income DisparityWhy do some individuals make millions and millions of dollars a year while the typical American wage earner was paid between $25,000 and $35,000There are several reasons but the bottom line is supply and demand29-3Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Supply of LaborNoncompeting groupsThere are three classes of laborSkilled, semiskilled, and unskilledIn a sense there are thousands of noncompeting groupsHowever, if there are opportunities in certain fields, people will go through the necessary training and compete for the jobsSo in another sense, we are all competitors in the same employment poolIn the long run most of us can learn to do many different jobsIn the short run we are all partial substitutes for one another 29-4Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Theory of the Dual Labor MarketThe theory of the dual labor market places the labor force into two broad categoriesThe primary market and the secondary marketThe primary market has most of the good jobs, which not only pay well but offer good opportunitiesThe secondary market market consist of all the jobs that are left overSo-called disposable workers fill these low pay, dead end, and often temporary jobs29-5Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Theory of the Dual Labor MarketThe theory of the dual labor market is a class theory of employmentThe rich stay rich and the poor stay poorThe college degree seems to be the dividing lineThe theory of the dual labor market does not account for the huge middle level of occupations, but it does support the contention that there are noncompeting groups in the labor market 29-6Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Labor Supply CurveThe substitution effectAs the wage rate rises, people are willing to substitute more work for leisure because leisure time is becoming more “expensive”The income effectAt some point, as your wage rate continues to rise, you are willing to give up some income in exchange for more leisure timeAfter all, you need more leisure time to spend all the money you are now making 29-7Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Hypothetical Labor Supply Curve29-8Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.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 LaborDemand is the firm’s Marginal Revenue Product schedule (MRP)The MRP schedule slopes down and to the rightWhen the price of a good is lowered, more of it is demanded; when it is raised, less is demandedThe demand for labor is a derived demandIt is derived from the demand for the final product that the labor produces29-9Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Hypothetical General Demand Curve for Labor29-10Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.This is the sum of every firm’s MRP curve. As the wage rate is lowered, increasing quantities of labor are demanded Labor and ProductivityObviously, workers who are more productive will generally be in more demand and better paid than less productive workersSome people are more productive because ofEducation and trainingWork experienceGreater natural abilities29-11Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Labor and ProductivityRelatively high productivity cannot be completely explained by educationIn many instances, people of widely varying productivity earn the same wage regardless of education or abilityProductivity only partially explains wage differentialsSpecialized skills possessed by some workers influence demand for laborSome workers are in demand because of natural abilities they possess29-12Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Nonhomogeneous JobsPay differentials adjust for harder, more unpleasant, less convenient workJust how does society get its dirty work done?By paying people enough to make it worth their whileBy calling on oppressed minorities to work at very low pay because they cannot get any other work29-13Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Hypothetical General Demand and Supply for Labor29-14Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.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 marketsHigh Wage Rates and Economic Rents29-15Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Determination of Economic Rent by Supply and DemandHow 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 millionWhen ever a person gets paid more than the minimum she would be willing to accept, we call the excess economic rent.Real Wages and ProductivityBy real wages, economist mean what you can actually buy Inflation erodes your purchasing powerA person earning $10,000 in 1970 would need about $40,000 today to maintain the same lifestyleWhy can’t we just give everyone pay increases that more than keep pace with inflation?Prices would just rise as fast or faster than your wage increases and your increasing dollars would buy less and lessThe key question is, “What can you buy with your money?” not, “How much money are you making?” 29-16Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Real Wages and ProductivityThe national standard of living can’t rise unless national production risesFor real wages to grow, output per labor-hour must growBetween 1947 and 1978 output per labor-hour rose 104%During this period real wages rose 105%Since 1978 output per labor-hour has risen only 1% a yearReal wages have not not increased at allReal wages and output per labor-hour have a parallel relationship 29-17Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Hourly Wages and Fringe Benefits in Manufacturing, 199929-18Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Real Wages versus Nominal Wages29-19Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Problem: Your wage rate rises from $5 an hour in 1993 to $8.40 an hour in 1999. Meanwhile the consumer price index (CPI) rises from 100 in 1993 (the base year) to 120 in 1999 (the current year). How much is your real hourly wage in 1999, and by what percentage has it increased since 1993Real Wages versus Nominal Wages29-20Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Problem: Your wage rate rises from $5 an hour in 1993 to $8.40 an hour in 1999. Meanwhile the consumer price index (CPI) rises from 100 in 1993 (the base year) to 120 in 1999 (the current year). How much is your real hourly wage in 1999, and by what percentage has it increased since 1993Real wage (current year) = X 100Money wages (current year)CPI (current year)Real Wages versus Nominal Wages29-21Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Problem: Your wage rate rises from $5 an hour in 1993 to $8.40 an hour in 1999. Meanwhile the consumer price index (CPI) rises from 100 in 1993 (the base year) to 120 in 1999 (the current year). How much is your real hourly wage in 1999, and by what percentage has it increased since 1993Real wage (current year) = X 100Money wages (current year)CPI (current year)= X 100$8.40120Real Wages Versus Nominal Wages29-22Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Problem: Your wage rate rises from $5 an hour in 1993 to $8.40 an hour in 1999. Meanwhile the consumer price index (CPI) rises from 100 in 1993 (the base year) to 120 in 1999 (the current year). How much is your real hourly wage in 1999, and by what percentage has it increased since 1993Real wage (current year) = X 100Money wages (current year)CPI (current year)= X 100$8.40120= $.07 X 100 = $7.00Real Wages versus Nominal Wages29-23Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Problem: Your wage rate rises from $5 an hour in 1993 to $8.40 an hour in 1999. Meanwhile the consumer price index (CPI) rises from 100 in 1993 (the base year) to 120 in 1999 (the current year). How much is your real hourly wage in 1999, and by what percentage has it increased since 1993Real wage (current year) = X 100Money wages (current year)CPI (current year)= X 100$8.40120= $.07 X 100 = $7.00Percentage change =ChangeOriginal numberReal Wages versus Nominal Wages29-24Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Problem: Your wage rate rises from $5 an hour in 1993 to $8.40 an hour in 1999. Meanwhile the consumer price index (CPI) rises from 100 in 1993 (the base year) to 120 in 1999 (the current year). How much is your real hourly wage in 1999, and by what percentage has it increased since 1993Real wage (current year) = X 100Money wages (current year)CPI (current year)= X 100$8.40120= $.07 X 100 = $7.00Percentage change =ChangeOriginal number $2 $5=Real Wages versus Nominal Wages29-25Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Problem: Your wage rate rises from $5 an hour in 1993 to $8.40 an hour in 1999. Meanwhile the consumer price index (CPI) rises from 100 in 1993 (the base year) to 120 in 1999 (the current year). How much is your real hourly wage in 1999, and by what percentage has it increased since 1993Real wage (current year) = X 100Money wages (current year)CPI (current year)= X 100$8.40120= $.07 X 100 = $7.00Percentage change =ChangeOriginal number $2 $5== .04 = 40% increaseReal Wages versus Nominal Wages29-26Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Problem: Ms. Klopman has been working at the same job since 1989, the base year. She was making $400 a week at that time, and now, in 1999, she is earning $540 a week. If the CPI rose to 180 to 1999 , how much are Ms. Klopman’s real wages in 1999 and by what percentage did they change?Real Wages versus Nominal Wages29-27Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Problem: Ms. Klopman has been working at the same job since 1989, the base year. She was making $400 a week at that time, and now, in 1999, she is earning $540 a week. If the CPI rose to 180 to 1999 , how much are Ms. Klopman’s real wages in 1999 and by what percentage did they change?Real wage (current year) = X 100Money wages (current year)CPI (current year)= X 100$540180= $3 X 100 = $300Percentage change =ChangeOriginal number $100 $400== .25 = 25% decreaseIndex 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 1970sThe Minimum Hourly Wage RateThe Fair Labor Standards Act of 1938Called for a 25-cent an hour minimum wage This was raised to 30 cents in 1939Called for a standard workweek of 44 hoursReduced to 40 hours in 1940Called for the payment of time and a half for overtimeTwenty-five cents in 1938 would buy approximately $3 worth of goods and services todayMinimum wageIn 1990 it was raised from $3.35 to $4.25In 1996 it was raised to $4.75In 1997 it was raised to $5.1529-29Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Minimum Wage and the Unemployment Rate29-30Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Monthly Unemployment Rate, 1996, 1997, and 1998 / 1996 1997 1998 January 5.7 5.3 4.7 February 5.5 5.3 4.6 March 5.7 5.2 4.7 April 5.5 5.0 4.3 May 5.5 4.8 4.4 June 5.3 5.0 4.5 July 5.4 4.9 4.5 August 5.2 4.9 4.5 September 5.2 4.9 4.5 October 5.2 4.8 4.5 November 5.3 4.6 4.4 December 5.3 4.7 4.4 Green indicates minimum wage increase in that particular month and yearShould There Be a Minimum Wage Rate?Conservatives say the minimum wage law hurts the very people it is supposed to help They claim the basic effect of the minimum wage is to cause millions of marginal workers to be unemployedThey point to rising teenage unemployment as proof29-31Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Hypothetical Demand and Supply Schedule for Unskilled Labor29-32Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The equilibrium wage rate is $3.75The minimum wage is $4.25There is a surplus of about 4 million workersHow many of these 4 million marginal workers would work for $3.75? Elastic Demand and Supply29-33Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The elimination of a minimum wage rate of $4.25 allows the wage rate to fall to its equilibrium level of $3.45, resulting in a jump in employment from 7 million to more than 18 millionElastic Demand and Inelastic Supply of Labor29-34Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The elimination of a minimum wage rate allows employment to rise from 7.3 million to just over 19 million29-35Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Eliminating the minimum wage raises employment only 0.4 millionInelastic demand and elastic supply Inelastic demand and supplyA Summing UpWill employment of unskilled and inexperienced workers rise if we eliminate the minimum wage?Yes. But the question is by how muchIt will rise very little if the demand for labor is very elasticThere is no question that teenagers, particular nonwhite teenagers are the last hired and the most poorly paidIs 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.Wages Are Set InstitutionallyWages are set institutionally with little regard to marginal analysisBecause wages are set institutionally, it makes little sense to abolish the minimum wage lawOn the other hand there is some truth to the contention that some teenagers are priced out of the labor market by the minimum wage. The question is, How many?There is also one eternal truth that cannot be ignoredThe price of labor, like the price of just about everything else, is affected by the law of supply and demand29-37Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.