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Labor Markets and Wage Rates
Supply of and Demand for Labor
“Economic Rent” and Wage Rates
Real Wages versus Money Wages
The Minimum Wage and the Living Wage
Demand and Supply of Labor
Obvious: Some people are paid more than others
• George Lucas -- $200 million• Oprah Winfrey -- $150 million• Steven Spielberg -- $100 million• Average American Worker -- $25-35 thousand
Primary Reason for disparity of income = Supply and Demand
The Supply of LaborNoncompeting Groups; Short-run vs Long-
Run In the short-run there are at least three categories or
strata of labor• Skilled Labor
Craftsmen Professional Other highly trained
• Semi Skilled Assembly line workers Supermarket checkers
• Unskilled Dishwashers General labor Strength versus think type work
The Supply of LaborNoncompeting Groups: Long-run
Opportunity for lesser trained to train for more skilled position
Higher paying jobs tend to attract more people who can then compete for those jobs
In the long run the categories tend to blur and Labor becomes quite mobile So, in the long run we are all competitors in
the same employment pool
The Supply of LaborTheory of the Dual Labor Market
A more radical, class theory of employment Primary Labor Market
• The Good jobs, such as• Professional positions• Management• Skilled technical
Secondary Labor Market• Not so good jobs Temporary• Low pay Little opportunity for advancement• Dead-end
The Rich stay rich and the poor stay poor
The Supply of LaborThe Backward-bending Labor Supply
Curve Begins with the concept that the higher the pay, the
more willing we are to substitute time at work for other activities
Who will work full time for $2/hour? Who will work full time for $40/hour? This is the substitution effect! As our pay is
increased, we are willing to spend more hours at work But there comes a time, when our incomes are
sufficient to meet our needs and we now begin to value leisure time and want to work less
This is called the income effect of labor supply
Hypothetical Labor Supply Curve
29-8Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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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 Labor
Recall from Chapter 14, the demand for a factor is the Marginal Revenue Product (MRP) for that factor, where the MRP = the change in total revenue
the change in factor input
The demand curve for labor slopes downward to the right in conformance with the MRP calculation and the general law of demand
Determinants of Factor Demand
Demand for Final Products Manufactured from Resources (Factors) – Called “Derived Demand”
Productivity of the Factor
Prices of Substitute Factors
Hypothetical General Demand Curve for Labor
29-10Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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This is the sum of every firm’s MRP curve. As the wage rate is lowered, increasing quantities of labor are demanded
Hypothetical General Demand and Supply for Labor
29-14Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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Hours worked per week (millions)*10 20 30 40 50 60 70 80
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 markets
Reasons for Pay Differentials
Supply/Demand factors in specific job markets Productivity from industry to industry Job content Industry profitability Culture and tradition “Winner take all markets”
High Wages and Economic Rent
Some people are paid extremely well for what they do
• Professional Sports• Movies• Television personalities
How Come? • Special abilities• High visibility• Supply of one
High Wages and Economic Rent
Whenever someone is paid more than he/she would be willing to work for, the difference is called “economic rent”
Text example: David Letterman makes $30 million/year
If Mr. Letterman would be willing to work for $5 million/year, the difference of $25 million is called economic rent
Still, it all boils down to Supply and Demand
High Wage Rates and Economic Rents
29-15Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
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Economicrent
Determination of Economic Rent by Supply and Demand
How 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 million
When ever a person gets paid more than the minimum she would be willing to accept, we call the excess economic rent.
Winner Take All Markets
American CEO’s earn on average about 500 times the salary of the average production worker
In Japan and Europe, CEO salaries much, much lower than in the U.S. Why?
CEO’s in the U.S. appear to be far more mobile than in Japan and Europe and therefore have been able to create a very inelastic supply curve where a few top performers walk away with the lion’s share of the total rewards
Also applies to professional sports, entertainment And is now impacting law, journalism, consulting, design,
fashion, etc. Diverting young talent into competition where most will lose
Real Wages versus Money Wages
By real wages, economists mean what you can actually buy with your wages
Inflation will erode a person’s purchasing power So, the important question is “what can you buy
with your money?” not “How much money are you making?”
Real wages measures the purchasing power of your income
Real Wages = Money Wages x 100 CPI (current Year)
Index 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 1970s
Declining Real Wages, 1973-1997
Never before in our history have real wages fallen over such an extended period of time
Period marked by five recessions Yet, Real GDP more than doubled
Why did real wages fall? and Productivity decline from late 1970’s thru mid 1990’s U.S. manufacturing outsourced production to Mexico,
Japan, Southeast Asia and China Switch from manufacturing to service industries
How did Americans maintain their standards of living? Continuing trend to two income households
Barely Getting By?
Beth Schulman – authored a book entitled The Betrayal of Work, 2003
Elizabeth Warren and Amelia Warren TyagiThe Two Income Trap, 2003
• Two income families worse off than their one income counterparts were in the 1970’s
• Middle class eroding and working poor are hurting• An opulent lifestyle of some is subsidized by low
wage work of millions• Perhaps law should mandate higher wages even if it
meant higher prices??
Minimum Wage; Living Wage
Minimum Wage – A price floor will cause a surplus of workers, ie. Unemployment & therefore
Minimum wage law hurts the very people it is supposed to help
Historical record is sporadic and would tend to indicate that other economic factors may outweigh the impact of present day minimum wage laws
Also, minimum wage increases have not kept pace with inflation – “real” minimum wage has fallen almost 40% since 1998
The Living Wage
Similar to a minimum wage but set higher to provide a “living wage”
Usually applied to contractors doing business with major municipalities New York City Los AngelesMinneapolisBoston Baltimore DenverCincinnati Chicago San Francisco
Studies show that unemployment slightly affected, but poverty rates have been moderately reduced
A Summing Up
Will employment of unskilled and inexperienced workers rise if we eliminate the minimum wage?
Yes. But the question is by how much It will rise very little if the demand for labor is very
elastic There is no question that teenagers, particular
nonwhite teenagers are the last hired and the most poorly paid
Is 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.