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The Labor MarketThe Labor Market
Economics, Sixth EditionEconomics, Sixth Edition
Boyes/MelvinBoyes/Melvin
Chapter 30Chapter 30
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Individual Labor SupplyIndividual Labor Supply
Households supply labor. People in the households allocate their time to work or to leisure. – This leads to individuals having to make a labor supply
decision based upon the labor-leisure tradeoff. The backward-bending labor supply curve results because
a person is willing and able to work more hours as the wage rate increases until, at some sufficiently high wage, the person chooses to work fewer hours. – The person feels that he or she has enough income, and
would rather have more leisure time. – At a high enough wage rate, the person feels that he or she
can afford to take more leisure time.
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The Individual’s The Individual’s Labor Supply Labor Supply CurveCurve
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Labor Market SupplyLabor Market Supply
The decision about whether or not to offer your labor services is a decision about labor force participation.
The backward bend and other features of the individual supply curves depends upon individual preferences.
When the individual supply curves are aggregated, the variations average out, and the labor market supply curve is upward sloping.
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The Labor Market Supply CurveThe Labor Market Supply Curve
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Labor Market Labor Market EquilibriumEquilibrium
Note: This model assumes that all workers and all jobs are the same.
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Wage DifferentialsWage Differentials
If all workers were identical, if all jobs were identical, and if all information were perfect, there would be no wage differentials—all workers would earn the same wage.
The reasons for wage differences include compensating wage differentials and differences in individual productivity.
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Compensating Wage DifferentialsCompensating Wage Differentials
Compensating wage differentials: wage differences that make up for the higher risk or poorer working conditions of one job over another.
Some jobs are more dangerous or more unpleasant. Workers demand higher wages to be willing to supply their labor to these jobs.
The supply curve of labor for these jobs lies above the supply curve of labor for less desirable jobs.
This results in a higher equilibrium wage and an equilibrium differential—the compensation the worker demands and gets for undertaking the riskier, less desirable job.
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Compensating Wage DifferentialsCompensating Wage Differentials
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Human CapitalHuman Capital
People differ with respect to their skills. These difference influence the level of wages for
two reasons:– Skilled workers have higher marginal productivity than
unskilled workers, and– The supply of skilled workers is smaller than the supply
of unskilled workers. As a result, skilled workers will receive higher
wages than unskilled workers. The expectation of higher wages will induce people
to acquire human capital—skills and training acquired through education and job experience.
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Human CapitalHuman Capital
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Investment in Human CapitalInvestment in Human Capital
Just as firms invest in physical capital, we say that individuals invest in human capital. – These individuals are purchasing education
and training in order to achieve higher output and income in the future.
As with all other economic decisions, the decision to invest in human capital is made in terms of whether the expected benefits will exceed the costs.
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Income Profiles and Income Profiles and Educational LevelEducational Level
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DiscriminationDiscrimination
Discrimination is a form of prejudice that occurs when factors unrelated to marginal revenue product affect the wages or jobs that are obtained. It is another reason for wage differentials.
Discrimination is costly in that less productive employees or more expensive but not more productive employees are used by the firm. It is contrary to profit maximization.
Discrimination may be personally based or statistical.– Personal discrimination is based upon prejudices on the part
of employers, fellow workers, or customers.– Statistical discrimination results when an indicator of group
performance is incorrectly applied to an individual member of that group.
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Occupational SegregationOccupational Segregation
Statistical discrimination and imperfect information can lead to crowding—forcing a group into certain kinds of occupations.
At one time, women were pushed into secretarial, clerical or support roles.
The separation of jobs by sex is called occupational segregation.
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DiscriminationDiscrimination
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CEO Pay PackagesCEO Pay Packages
CEOs earn more than 200 times as much as the average worker.
In 2002, the median salary of CEOs in companies listed in the S&P 500 stock index was $7 million.
How could anyone justify such large salaries for CEOs and differences between the pay of top CEOs and the average worker?
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Explaining CEO Salaries (1)Explaining CEO Salaries (1)
One answer is that the market failed.– The owners of firms exert little day-to-control
over CEOs and the CEO’s pay.– CEOs take advantage of this and award
themselves large salaries.– But CEO salaries are set by the boards of
directors, not by the CEOs themselves. Another answer is that the board members
conspire to pay high wages because the CEO may sit on the boards of directors of the firms that set their salaries.
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Explaining CEO Salaries (2)Explaining CEO Salaries (2)
A third explanation has to do with the nature of the compensation package that CEOs receive.– In 1999 salary accounted for just 9.73% of the
compensation of CEOs. – Stock options accounted for 58.52%.– The idea is that if the CEO manages the firm correctly,
the stock price will rise, and the CEO will enjoy a large salary. Thus the CEO’s incentives are consistent with the interests of the shareholders of the company.
– In 2001 and 2002, the stock market broadly declined, which was blamed on general economic conditions. To retain CEOs in the face of this, firms began to raise their base salaries.
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Explaining CEO Salaries (3)Explaining CEO Salaries (3)
When the CEO is generating enormous incomes for shareholders, the shareholders are very willing to pay the CEO handsomely.
In essence, the marginal revenue product of the CEO warrants the high pay.
It is harder to understand when CEOs are paid high salaries while their companies lose money. In some cases it is argued that the losses would have been higher had the company had a less-talented CEO.
The high CEO salaries may serve as incentives to those who have not yet achieved CEO status, making them more productive.
Another explanation is the superstar effect: people with small differences in abilities or productivity receive vastly different levels of compensation.
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Wage DifferentialsWage Differentialsand Government Policiesand Government Policies Since the 1930s, about 30 states enacted for
employment practice laws prohibiting discrimination in employment on the basis of race, color, creed, or national origin. (Sex discrimination was not covered.)
With the Civil Rights Act of 1964 it became unlawful for any employer to discriminate on the basis of race, color, religion, sex, or national origin.
Exceptions are only permitted in cases where religion, sex, or national origin is a bona fide occupational qualification for the job.
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Tests of DiscriminationTests of Discrimination
Disparate treatment: treating individuals differently because of their race, sex, color, religion, or national origin.
Disparate impact: it is the result of different treatment, not the motivation, that matters.
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Comparable WorthComparable Worth
The persistent wage gap between men and women has led to another approach— “equal pay for equal work”.
More formally, this is called comparable worth—the pay ought to be determined by the job characteristics rather than by supply and demand, and jobs with comparable requirements should receive comparable wages.
Proponents of this approach argue that market-determined wages are not appropriate because of the market’s inability to assess marginal products.
Opponents argue that interference with the function of the labor market will lead to shortages in some occupations and excess supplies in others.
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Comparable WorthComparable Worth