Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Chapter 8

The Wage Structure

8-2

1. Perfect Competition: Homogenous Workers and Jobs

8-3

Homogenous Workers and Jobs

• Assume that the wage of $10 in submarket a is higher than the wage in other submarkets.• Assuming that jobs and workers are homogenous and information and mobility is costless, workers will leave the other submarkets for higher paying submarket a.

• The equilibrium wage rate will decrease in submarket a and rise in the other submarkets until the wage rate is the same in all submarkets ($8).

Quantity of Labor Hours

Wage rateS0a

D0a

Q0

$10

S1a

Q1

$8

• This will decrease the labor supply in the other submarkets and increase the labor supply in submarket a (S0 to S1).

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2. The Wage Structure: Observed Differential

8-5

Hourly Earnings By Occupational Group, 2008

Occupational Group Hourly Wage

Management, Business, And Financial $31.50Installation, Maintenance, And Repair $19.76Sales Workers $17.58Office and Administrative Support $15.78Service Workers $12.74Farming, Fishing, And Forestry $11.29

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Hourly Earnings By Industry Group, 2008

Industry Group Hourly Wage

Finance, insurance, real estate $25.55

Mining $25.32

Public administration $25.27Transportation, warehousing, information, and utilities $22.88

Manufacturing $22.60

Construction $20.23

Services $19.63

Retail trade $14.50

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Private Manufacturing Worker’s Hourly Earnings By State, 2008State Hourly Wage

New Jersey $29.69 California $27.16 Texas $22.79 New York $22.42 Florida $20.71 Iowa $19.13 Alabama $18.23 Arkansas $15.77 Mississippi $14.95

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3. Wage Differentials: Heterogenous Jobs

8-9

Compensating Differentialso Compensating wage differentials

consist of extra pay that an employer must provide a worker for some undesirable job characteristic that does not exist in alternative employment.

• The wage differential is caused by a decreased labor supply for the job that has the undesirable job characteristic and an increased labor supply for the alternative employment.

8-10

Compensating Differentialso Sources of compensating differentials

• Risk of job injury or death∞Riskier jobs pay higher wages.

• Fringe benefits∞Jobs with greater fringe benefits pay lower wages.

• Job status∞Jobs with greater prestige pay lower wages.

• Job location∞Cities with greater amenities pay lower wages.

∞Cities with greater cost of living pay higher nominal wages.

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Compensating Differentials• Job security

∞Jobs with greater job security pay lower wages.

• Prospect of wage advancement∞Jobs with greater wage advancement have lower

starting wages.

• Extent of control over the work place∞Jobs with less personal control over the workplace

and less flexible work hours pay higher wages.

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Differing Skill Requirements

o Jobs that require more education and training will pay a higher wage rate than those that do not.• The wage difference between skilled and

unskilled workers is called the skill differential.

o Skill differentials can increase, decrease, or reverse wage differences caused by compensating differentials.• Example: Nurses earn more than ditch diggers.

8-13

Efficiency Wage Payments

o Shirking model• Firms will pay above-market wages where

it is costly to monitor employee performance or the employer’s cost of poor performance is high.

o Turnover model• Firms will pay above-market wages when

hiring and training costs are high.

o Empirical evidence is mixed.

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Other Job or Employer Heterogeneities

o Union status• Union workers earn more than nonunion

workers.∞Most of the differential is an economic rent to

union workers.

o Discrimination• Discrimination against women and

minorities exists in some markets and creates wage differentials.

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Other Job or Employer Heterogeneities

o Firm size• Large firms pay higher wages than small

firms.∞Large firms are more likely to be unionized.∞Workers at large firms may be more

productive.~ Training, better workers, greater capital

∞Higher wages may be a compensating wage differential.

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4. Wage Differentials: Heterogenous Workers

8-17

NonCompeting Groupso Individuals differ in the type, amount,

and quality of their human capital.• The result is the labor force consists of

noncompeting groups of workers that are not easily substitutable for each other.

• In the short run, these differences in human capital generate wage differentials.

• In the long run, the wage differentials cause individuals to move to higher paying jobs to some extent.

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Differing Preferenceso Differences in time preferences

• Persons who are present-oriented (i.e., have a high discount rate) are not willing to sacrifice present consumption without a large increase in future income.

• Persons who are future-oriented (i.e., have a high discount rate) are willing to sacrifice present consumption for a small increase in future income.

• Persons with lower discount rates acquire more human capital and thus create wage differentials.

8-19

Differing Preferenceso Differences in tastes for nonwage aspects

of jobs• People have different preferences for job

security, location, and risk.• These differences in preferences create wage

differentials.

8-20

Questions for Thought1. Discuss: “Many of the lowest-paid people in the

society—for example, short-order cooks– also have relatively poor working conditions. Hence, the theory of compensating wage differentials is disproved.”

2. Explain why “pay comparability” legislation requiring that the public sector remunerate government employees at wages equal to private-sector counterparts might create excess supplies of labor in public-sector labor markets.

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5. The Hedonic Theory of Wages

8-22

Indifference Map

• The “hedonic” indifference map is composed of a number of indifference curves.

Nonwage amenity (job safety)

Wage Rate

I1

I2

I3

• Each individual curve shows the various combinations of wage rates and a particular nonwage amenity (for example job safety) that yield a specific level of total utility.

• Each curve to the northeast reflects a higher level of total utility.

• A steep curve implies that the person is risk averse—it takes a large increase in the wage rate to compensate for a small reduction in job safety.

8-23

Isoprofit Curve

Nonwage amenity (job safety)

Wage Rate

P

• The employer’s isoprofit curve shows the various combinations of wage rates and a particular nonwage amenity (for example job safety) that yield a given level of total profit.

• Competition among firms will result in only normal profits (zero economic profit) in the long run.

• Firms will have to make their wage rate-job amenity decisions along a curve such as P.

• The isoprofit curve gets steeper with higher levels of job safety since it gets more and more expensive to increase job safety.

• Firms differ in their ability to increase job safety and thus have different isoprofit curves.

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Matching• The slope of isoprofit curve PA is less steep than curve PB, which implies the marginal cost of job safety is more expensive at firm B than at firm A.

• Workers maximize utility by being tangent to the highest possible isoprofit curve.

• The risk averse worker will work for the firm able to raise safety at low marginal cost. The worker will get wage WA and safety SA.

• Indifference curve IA is steeper than curve IB which implies that person A is more risk averse than person B.

• The risk loving worker will work for the firm able to raise safety at high marginal cost. The worker will get wage WB and safety SB.

A

SA

WA

IB

IA

PA

Nonwage amenity (job safety)

Wage Rate

PB

B

SB

WB

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Labor Market Implicationso Workers with fewer nonwage amenities will

get higher wages.o Laws with minimum safety standards may

reduce utility of some workers.• Risk loving workers would prefer higher wages

to greater safety.

o Part of the male-female wage differential may reflect differences in preferences for nonwage amenities.• Women may prefer shorter commuting distances

and safer jobs.

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Labor Market Implicationso Workers with strong preferences for

fringe benefits will match up with firms that can provide fringe benefits at low cost.• Cafeteria plans which allow workers to

choose from a variety of fringe benefits allow workers to get higher utility since they are not forced to accept a fixed bundle.

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6. Wage Differentials: Labor Market Imperfections

8-28

Wage Rate Distributions• If information and job search is costly, then a single equilibrium wage for a specific occupation is not likely to occur.• A range of possible wages will exist for an occupation.

• These wage differentials will not cause job switching since the expected marginal benefits of the higher wage are exceeded by the expected marginal cost of obtaining the information.

• In this example, 20 percent of workers will earn between $8.80 and $8.99 per hour. However, 5% of the workers will earn between $8.00 and $8.19, while another 5% will earn between $9.60 and $9.79.

5%

8%

12%

15%

20%

15%

12%

8%

5%

0%

5%

10%

15%

20%

25%

Wage Rate

8.0 8.2 8.4 8.6 8.8 9.0 9.2 9.4 9.6

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Lengthy Adjustment Period• An increase in labor demand initially may cause a substantial wage increase to W0 in occupations with lengthy training periods.

• For a time the wage rate may oscillate above and below the long-run equilibrium wage rate We before equilibrium in the market is finally restored.

• But the supply response to higher wage may create surplus of labor to the occupation in the next period, driving the wage rate lower to W1.

• During the transition periods, wage differentials between this occupation and others paying We will be observed.

Units of Time

Wage Rate

W0

W1

W2

W3

WeWe

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Immobilitieso Labor immobilities are

impediments to the movement of labor and can cause wage differentials.

o Geographic immobilties• Costs to moving can deter migration

and thus permit wage differentials to exist across geographic areas.

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Immobilities

o Institutional immobilties• Restrictions on mobility imposed by

the government or unions can deter mobility.

∞Occupational licensing, apprenticeships

o Sociological immobilties• Race and gender discrimination will

cause racial and gender wage differentials to exist.

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Question for Thought1. Suppose that (a) employees must pay higher

wages to attract workers from wider geographic areas and hence higher wages are associated with longer commuting distances (less of the amenity “closeness of job to home”) and (b) females have greater tastes for having jobs close to their homes than males. Use the hedonic wage model to show graphically why a male-female wage differential might emerge, independently of skill differences or gender discrimination.