13

Wage Determination

Labor, Wages ,and Earnings

• Wages• Price paid for labor• Direct pay plus fringe benefits

• Wage rate• Nominal wage• Real wage• General level of wages

LO1 13-2

Global Perspective

LO1 13-3

Role of Productivity

• Labor demand depends on productivity

• U.S. labor is highly productive• Plentiful capital• Access to abundant natural

resources• Advanced technology• Labor quality• Other factors

LO1 13-4

Real Wages and Productivity

• Long-run trend of average real wages in the U.S.

Rea

l Wag

e R

ate

(Dol

lars

)

Quantity of Labor

LO1 13-5

D1900

S1900

D1950

S1950

D2000

S2000

D2020

S2020

Real Wages and Productivity

LO1 13-6

Competitive Labor Market

• Market demand for labor• Sum of firm demand• Example: carpenters

• Market supply for labor• Upward sloping• Competition among industries

• Labor market equilibrium• MRP = MRC rule

LO2 13-7

Wag

e R

ate

(Dol

lars

)

Labor Market

Quantity of Labor

Wag

e R

ate

(Dol

lars

)

Individual Firm

Quantity of Labor

0 0

Competitive Labor Market

LO2 13-8

D=MRP(∑ mrp’s) d=mrp

S

($10)WCR

ate

QC(1000)

($10)WCR

ate s=MRC

(5)qC(5)

c

b

a

e

Monopsony Model

• Employer has buying power• Characteristics

• Single buyer• Labor immobile• Firm “wage maker”

• Firm labor supply is upward sloping• MRC higher than wage rate• Equilibrium

LO3 13-9

• Examples of monopsony power

Monopsony Model

LO3 13-10

Wag

e R

ate

(Dol

lars

)

Quantity of Labor

0

MRP

S

a

Qc

Wc

MRC

b

Qm

cWm

• Examples of monopsony power

Monopsony Model

LO3 13-10

Wag

e R

ate

(Dol

lars

)

Quantity of Labor

0

MRP

S

a

Qc

Wc

MRC

b

Qm

cWm

Monopsony Power

• Maximize profit by hiring smaller number of workers

• Examples of monopsony power• Nurses• Professional Athletes• Teachers

• Three union models

LO3 13-11

Demand Enhancement Model

• Union model• Increase product demand• Alter price of other inputs

LO4 13-12

Wag

e R

ate

(Dol

lars

)

Quantity of Labor

D1

S

Wc

Qc

IncreaseIn DemandInIn

D2

Wu

Qu

Craft Union Model

• Effectively reduce supply of labor• Restrict immigration• Reduce child labor• Compulsory retirement• Shorter workweek

• Exclusive unionism• Occupational licensing

LO4 13-13

Craft Union Model

LO4 13-14

Wag

e R

ate

(Dol

lars

)

Quantity of Labor

D

S1

Wc

Qc

DecreaseIn Supply

S2

Wu

Qu

Industrial Union Model

• Inclusive unionism• Auto and steel workers

LO4 13-15

Wag

e R

ate

(Dol

lars

)

Quantity of Labor

D

S

Wc

Qc

be

Qe

Wua

Qu

Industrial Union Model

• Inclusive unionism• Auto and steel workers

LO4 13-15

Wag

e R

ate

(Dol

lars

)

Quantity of Labor

D

S

Wc

Qc

be

Qe

Wua

Qu

Union Models

• Are unions successful?• Wages 15% higher on average

• Consequences:• Higher unemployment• Restricted ability to demand higher

wages

LO4 13-16

Bilateral Monopoly Model

• Monopsony and inclusive unionism• Single buyer and seller• Not uncommon• Indeterminate outcome• Desirability

LO4 13-17

Bilateral Monopoly Model

LO4 13-18

Wag

e R

ate

(Dol

lars

)

Quantity of Labor

D=MRP

S

aWc

Qc

MRC

Wu

Qu=Qm

Wm

Bilateral Monopoly Model

LO4 13-18

Wag

e R

ate

(Dol

lars

)

Quantity of Labor

D=MRP

S

aWc

Qc

MRC

Wu

Qu=Qm

Wm

Bilateral Monopoly Model

LO4 13-18

Wag

e R

ate

(Dol

lars

)

Quantity of Labor

D=MRP

S

aWc

Qc

MRC

Wu

Qu=Qm

Wm

The Minimum Wage Controversy

• Case against minimum wage• Case for minimum wage• State and locally set rates• Evidence and conclusions

LO5 13-19

Wage Differentials

LO5 13-20

Wage DifferentialsW W

WW

Q

Q Q

Q0

0 0

0

(a) (b)

(c) (d)

LO5 13-21

Sa Sb

Sc

SdSd

Da

Db

Dc Dd

Wa

Wc

Wb

Qa Qb

Qc

Wd

Qd

Wage DifferentialsW W

WW

Q

Q Q

Q0

0 0

0

(a) (b)

(c) (d)

LO5 13-21

Sa Sb

Sc

SdSd

Da

Db

Dc Dd

Wa

Wc

Wb

Qa Qb

Qc

Wd

Qd

Wage Differentials

• Differences across occupations• What explains wage differentials?• Marginal revenue productivity• Noncompeting groups

• Ability• Education and training

• Compensating differences

LO5 13-22

Wage Differentials

LO5 13-23

Wage Differentials

• Workers prevented from moving to higher paying jobs

• Market imperfections• Lack of job information• Geographic immobility• Unions and government restraints• Discrimination

LO5 13-24

Pay for Performance

• The principal-agent problem • Incentive pay plan

• Piece rates• Commissions or royalties• Bonuses, stock options, and profit

sharing• Efficiency wages

• Negative side-effects

LO6 13-25

Are CEOs Overpaid?

• U.S. CEO salaries relatively high• Good decisions enhance productivity• Limited supply, high MRP• Incentive to raise productivity at all

levels• High salary bias by board members • Unsettled issue

LO6 13-26