Chapter 17 - Labor, Wages, and Earnings PDF

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Labor, Wages, and Earnings
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Chapter 17 In this chapter we examine how wages are determined in competitive markets and imperfectly competitive markets. We look at factors that impact wages, including the influence of unions. We will analyze wage differences with union models including craft unions and industrial unions and discuss reasons for wage differentials across jobs and analyze the effects of the minimum wage on the labor market. The Last Word is about how occupational licensing restricts competition.

Labor, Wages, and Earnings • Wages • Price paid for labor • Direct pay plus fringe benefits • Wage rate • Nominal wage • Real wage General level of wages The term “labor” is used to refer to virtually any type of worker: blue-collar, whitecollar, hourly, salaried, professional, etc. Wages, the price paid for labor, include not only direct money payments but also fringe benefits like vacations and health insurance. A nominal wage is the amount of money received per hour, day, or year. A real wage is the quantity of goods and services a worker can obtain with nominal wages or the “purchasing power” of nominal wages. Wage rates differ greatly among nations, regions, occupations, and individuals. Wages of Production Workers The data shown here indicate that hourly compensation in the United States is not as high as in some European countries but is higher than other nations. Generally speaking, the level of real wages in the United States is relatively high as in most other industrially advanced economies. In those nations, the demand for labor is relatively large compared to the supply of labor. 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 The demand for labor, like other resources, depends on its productivity. The greater the productivity of labor, the greater is the demand for it. And if the supply of labor is relatively fixed, that means the average level of real wages will be higher. The U.S. and other advanced economies benefit from highly productive labor. This is due to the plentiful capital available in these nations, access to abundant natural resources, advanced technology, the quality of the labor, and other less obvious factors such as a social and political environment that emphasizes production and productivity. Competitive Labor Market • Purely 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 Because wage rates vary greatly by occupation, it is useful to look at the factors that determine the wage rate paid for a specific type of labor under different conditions. We begin by examining labor supply and demand in a purely competitive labor market. The market demand for labor is determined by the horizontal sum of the labor demand curves of the individual firms. The market supply for labor is illustrated by an upward-sloping supply curve, indicating that employers must pay higher wage rates to obtain more workers. The labor market equilibrium is determined by the intersection of the market labor demand curve and the market labor supply curve.

Labor Market and the Firm These graphs demonstrate the labor supply and labor demand in a purely competitive labor market and a single competitive firm. In an individual firm, the labor supply curve is represented by a horizontal line because it is perfectly elastic. The labor demand curve for the individual firm is downward sloping reflecting the fact that to attract more workers, the firm must pay more. The firm will maximize profits by hiring workers up to where MRP = MRC. Monopsony • Monopsony • Employer has buying power • Characteristics • Single buyer • Labor immobile • Firm is a “wage maker” • Upsloping labor supply to firm MRC higher than wage rate In a monopsony market, there is only one buyer for labor. The workers who provide the type of labor needed have few employment options other than working for the monopsony, maybe because they are geographically immobile or their skills are not transferable to other jobs. This makes the firm a “wage maker,” meaning that the wage rate it must pay varies directly with the number of workers available. In this case, the firm’s labor supply curve will be upward sloping and the MRC will be higher than the wage rate. To maximize profit, the monopsonist will employ the quantity of labor at which MRC and MRP are equal. Monopsony Power • Maximize profit by hiring smaller number of workers • Examples of monopsony power • Nurses • Professional Athletes • Teachers

The monopsonist will maximize profits by employing a smaller number of workers and paying a lower wage than the competitive market. Society will obtain a smaller output and workers receive a wage rate that is less than their marginal revenue product. While monopsonistic labor markets are uncommon in the United States, there are a few examples. In the medical area, nurses are typically limited in their choice of employers to the relatively small number of hospitals that may be in their area. Likewise, professional athletes are limited through player drafts to specific employers only. In some situations, labor market workers unionize and create their own monopsonistic power. Demand Enhancement Model The demand enhancement model is the first of three union models examined in this chapter. Unions can increase the demand for their labor by increasing the demand for the goods and services they help produce. This can be accomplished through political lobbying and/or supporting government policies pertaining to either input prices or to the price of some complementary resource. Here, an increase in the demand for union labor will create a higher union wage along with more jobs. In this graph, we can see the effect of an increase in the demand for labor on the wage rate. Craft Unions • Effectively reduce supply of labor • Restrict immigration • Reduce child labor • Encourage compulsory retirement • Enforce a shorter workweek • Exclusive unionism Occupational licensing A second union model is the craft union model. In this model, some unions attempt to restrict the supply of labor available and thus affect the wage rate paid. Labor unions have supported legislation that has restricted immigration, reduced child labor, encouraged compulsory retirements, and created a shorter workweek. Craft unions especially tend to control the supply of labor by requiring workers to belong to the union in order to obtain certain jobs. They may force employers to

agree to hire only craft union members. The craft union then maintains restrictive membership policies to control the labor supply. A similar situation exists in many professional occupations which may push for legislation requiring occupational licensing as a way to control the supply of labor. By excluding workers from the craft unions, such as carpenters, brick masons, or plumbers, they have restricted the labor supply and succeeded in increasing wage rates. Industrial Union Model The third union model is the industrial union model where unions seek to organize all available workers, rather than just a select few. Industrial unions seek all available unskilled, semiskilled, and skilled workers in an industry. By including such a large number of workers, the union can put the firm under great pressure to agree to its wage demands, especially due to its legal right to strike. By agreeing to the union’s wage demand, the firm becomes a wage taker. The labor supply becomes perfectly elastic, creating a higher wage rate but again, reducing the number of workers employed. Wage Increases and Job Loss • Are unions successful? • Wages 15% higher on average • Consequences • Higher unemployment • Restricted ability to demand higher wages There is much debate as to whether or not labor unions have been successful at raising the wages of their members. Some evidence suggests that union wages are on average 15% higher than the wages of non-union workers. However, both exclusive and inclusive unionism tends to reduce employment in unionized firms. This decline in employment has the effect of restricting the ability of the union to demand higher wages. Workers will balk against wage rate requests so high that many workers might lose jobs. Bilateral Monopoly • Bilateral monopoly

• Monopsony and inclusive unionism • Single buyer and seller • Not uncommon Indeterminate outcome Bilateral monopolies occur when there is a strong industrial union in a monopsonist labor market. In this case, there is both a single buyer and seller of labor. The effect on the wage rate is indeterminate since it will depend on which party has the greater bargaining power. The Minimum Wage Controversy • • • •

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

Since the passage of the Fair Labor Standards Act in 1938, the United States has had a federal minimum wage designed to ensure workers earn at least an amount sufficient to support themselves and their families at a basic subsistence level. Some states have passed minimum wage laws of their own with a higher rate than the federal minimum rate. The federal minimum wage at present is $7.25 per hour (July 2009). Critics argue that the minimum wage, if it is above the equilibrium wage rate, will cause employers to hire fewer workers and may even force some firms out of business since they cannot afford to pay the higher rate. They also argue that many of the workers who receive this minimum rate, such as teenagers, do not actually live in impoverished households and are not selfsupporting so do not need a guaranteed minimum. Advocates of minimum wage argue that in many low-pay labor markets, employers exercise monopsonistic power and thus a required minimum wage can increase wage rates without causing significant unemployment. There is no clear answer as to which view is correct. On the one hand, the employment and unemployment effects of the minimum wage do not appear to be as great as many critics fear. On the other hand, the minimum wage is not as strong an antipoverty tool as supporters contend since a large part of its effect is dissipated on nonpoverty families. Wage Differences

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Wage differences across occupations What explains wage differentials Marginal revenue productivity Noncompeting groups Skills Education and training Human capital Compensating differences

Wages differentials are wage differences created by many different forces and can arise from either the supply or the demand side of the labor market. Even across one occupation, wage differentials can occur. For example, a surgeon just starting out would expect to make much less than one who has many years of experience. If we focus on the affect of the labor demand on the wage differential, we can see that the strength of the labor demand varies greatly among occupations due to differences in how much various occupational groups contribute to the revenue of their respective employers. The marginal revenue productivity of these types of workers is high. We can see this illustrated in the demand for professional athletes. On the supply side, workers differ greatly in their skill sets, as well as their mental and physical characteristics and their education and training. In some groups, there may be fewer qualified workers than in other groups, leading to higher wages rates for those limited workers. Human capital is the accumulation of outcomes of prior investments in education, training, and other factors that increase productivity and earnings. Compensating differences are wages that must be paid to compensate for nonmonetary differences in various jobs. Undesirable jobs must pay higher wages to recruit workers who could just as easily qualify for less demanding positions. Other Reasons • Workers prevented from moving to higher paying jobs • Market imperfections • Lack of job information • Geographic immobility • Unions and government restraints • Discrimination

Why don’t workers just move from lower-paying jobs to higher-paying jobs? Several reasons can be the cause. Frequently there are market imperfections at work. Workers may not be aware that there are higher-paying jobs for which they qualify. They may not be able to move to locations where higher-paying jobs exist because they do not want to leave their families or friends. Unions and other government restraints may also artificially reinforce wage differentials. And in spite of legislation to the contrary, discrimination in the workforce still results in lower wages frequently being paid to women and minority groups. 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 Pay schemes are typically much more complex than just a fixed hourly rate. Employers may use worker pay to encourage a desired level of performance from workers. In the principal-agent problem, the interests of workers and firms are not identical, resulting in situations where workers seek to increase their utility by working less than agreed upon. To prevent this, many firms employ incentive pay plans whereby worker compensation is tied to worker output or performance. This may be accomplished in several ways. Piece rates compensate employees according to the number of units of output a worker produces. Commission or royalties tie compensation to the value of sales. Bonuses, stock options, and profit-sharing plans tie compensation to the profitability of the firm, and efficiency wages seek to enhance worker efficiency or to encourage workers to work harder. Pay for performance plans do have their negative side-effects. Piece rates may encourage rapid production at the expense of product quality. Commissions, bonuses, stock option, and profit-sharing plans can encourage unethical behavior among employees in order to increase their own personal income at the expense Occupational Licensing

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Makes sense for doctors and EMTs But interior designers? Nearly 1 in 3 jobs today require a license Restricts competition and increases price Burden on consumers and workers Low-wage jobs like cosmetology, childcare, floristry, massage therapy, and travel agency require licenses today

Licensing requirements are ostensibly used to protect the public but this has expanded today to jobs where public safety really isn’t an issue, like interior design. Today, 3 states require a license to operate as an interior designer. This license requires 6 years of training and internships before even applying for the license. This requirement limits the number of interior designers and raises the price that they can charge. In the 1950s about 1 in 20 jobs required a license, today about 1 in 3 do; many in low-wage jobs like cosmetology, childcare, floristry, barbering, bus driving, bartending, tree trimming, hair braiding, massage therapy, and travel agency. This unnecessarily limits the job opportunities for poorer workers. Instead of working as soon as any needed training is completed, they are forced to go through months or years of costly requirements whose only purpose is to limit competition for those who already have licenses. This is a major impediment to poor people hoping to set up their own businesses or switch careers....