Labor Markets and Wage Rates Chapter 28 Labor Markets and Wage Rates 28-1 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Objectives The supply of labor The demand for labor High wage rates and economic rent Real wages and productivity The minimum wage The living wage 28-2 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Income Disparity Why do some individuals make millions and millions of dollars a year while the typical American wage earner was paid between $25,000 and $35,000 There are several reasons but the bottom line is supply and demand 28-3 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

The Supply of Labor Noncompeting groups There are three classes of labor Skilled, semiskilled, unskilled In a sense there are thousands of noncompeting groups However, if there are opportunities in certain fields, people will go through the necessary training and compete for the jobs So in another sense, we are all competitors in the same employment pool In the long run most of can learn to do many different jobs In the short run we are all partial substitutes for one another 28-4 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

The Theory of the Dual Labor Market The theory of the dual labor market places the labor force into two broad categories The primary market and the secondary market The primary market has most of the good jobs, which not only pay well but offer good opportunities The secondary market market consist of all the jobs that are left over So-called disposable workers fill these low-pay, dead end, and often temporary jobs 28-5 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

The Theory of the Dual Labor Market The theory of the dual labor market is a class theory of employment The rich stay rich and the poor stay poor The college degree seems to be the dividing line However, you also need to be educated – the two are not necessarily synonymous The theory of the dual labor market does not account for the huge middle level of occupations but it does support the contention that there are noncompeting groups in the labor market 28-6 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

The Backward-Bending Labor Supply Curve The substitution effect As the wage rate rises, people are willing to substitute more work for leisure because leisure time is becoming more expensive The income effect At some point, as your wage rate continues to rise, you are willing to give up some income in exchange for more leisure time After all, you need more leisure time to spend all the money you are now making 28-7 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Labor Supply Curve A person will be willing to work an increasing amount of hours per week as the hourly wage rate goes up. But at 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 28-8 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

The Demand for Labor Demand is the firm’s Marginal Revenue Product schedule (MRP) The MRP schedule slopes down and to the right When the price of a good is lowered, more of it is demanded; when it is raised, less is demanded The demand for labor is a derived demand It is derived from the demand for the final product that the labor produces 28-9 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical General Demand Curve for Labor This is the sum of every firm’s MRP curve. As the wage rate is lowered, increasing quantities of labor are demanded 28-10 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Labor and Productivity Obviously, workers who are more productive will generally be in more demand and better paid than less productive workers Some people are more productive because of Education and training Work experience Greater natural abilities 28-11 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Labor and Productivity Relatively high productivity cannot be completely explained by education In many instances, people of widely varying productivity earn the same wage regardless of education or ability Productivity only partially explains wage differentials Specialized skills possessed by some workers influence demand for labor Some workers are in demand because of natural abilities they possess 28-12 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Nonhomogeneous Jobs Pay differentials adjust for harder, more unpleasant, less convenient work Just how does society get its dirty work done? By paying people enough to make it worth their while By calling on oppressed minorities to work at very low pay because they cannot get any other work 28-13 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical General Demand and Supply for Labor 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 28-14 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

High Wage Rates and Economic Rents 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. 28-15 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Real Wages and Productivity By real wages, economists mean what you can actually buy with your wages Inflation erodes your purchasing power A person earning $10,000 in 1970 would need about $40,000 today to maintain the same lifestyle Why can’t we just give everyone pay increases that more than keep pace with inflation? Prices would just rise as fast or faster than your wage increases and your increasing dollars would buy less and less The key question is, “What can you buy with your money?” not, “How much money are you making?” 28-16 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Real Wages versus Nominal Wages The national standard of living can’t rise unless national production rises For real wages to grow, output per labor-hour must grow Between 1947 and 1978 output per labor-hour rose 104 percent During this period real wages rose 105 percent Since 1978 output per labor-hour has risen only 1 percent a year Real wages have not not increased at all Real wages and output per labor-hour have a parallel relationship 28-17 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Indexes of hourly compensation cost in U. S Indexes of hourly compensation cost in U.S. dollars for production workers in manufacturing, U.S. and selected countries, 2001 28-18 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Real Wages versus Nominal Wages Problem: Your wage rate rises from $5 an hour in 1993 to $8.40 an hour in 1999. Meanwhile the consumer price index (CPI) rises from 100 in 1993 (the base year) to 120 in 1999 (the current year). How much is your real hourly wage in 1999, and by what percentage has it increased since 1993 29-19 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Real Wages Versus Nominal Wages Problem: Your wage rate rises from $5 an hour in 1993 to $8.40 an hour in 1999. Meanwhile the consumer price index (CPI) rises from 100 in 1993 (the base year) to 120 in 1999 (the current year). How much is your real hourly wage in 1999, and by what percentage has it increased since 1993 Money wages (current year) Real wage (current year) = X 100 CPI (current year) 29-20 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Real Wages Versus Nominal Wages Problem: Your wage rate rises from $5 an hour in 1993 to $8.40 an hour in 1999. Meanwhile the consumer price index (CPI) rises from 100 in 1993 (the base year) to 120 in 1999 (the current year). How much is your real hourly wage in 1999, and by what percentage has it increased since 1993 Money wages (current year) Real wage (current year) = X 100 CPI (current year) $8.40 = X 100 120 29-21 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Real Wages Versus Nominal Wages Problem: Your wage rate rises from $5 an hour in 1993 to $8.40 an hour in 1999. Meanwhile the consumer price index (CPI) rises from 100 in 1993 (the base year) to 120 in 1999 (the current year). How much is your real hourly wage in 1999, and by what percentage has it increased since 1993 Money wages (current year) Real wage (current year) = X 100 CPI (current year) $8.40 = X 100 120 = $.07 X 100 = $7.00 29-22 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Real Wages versus Nominal Wages Problem: Your wage rate rises from $5 an hour in 1993 to $8.40 an hour in 1999. Meanwhile the consumer price index (CPI) rises from 100 in 1993 (the base year) to 120 in 1999 (the current year). How much is your real hourly wage in 1999, and by what percentage has it increased since 1993 Money wages (current year) Real wage (current year) = X 100 CPI (current year) $8.40 = X 100 120 = $.07 X 100 = $7.00 Change Percentage change = Original number 29-23 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Real Wages versus Nominal Wages Problem: Your wage rate rises from $5 an hour in 1993 to $8.40 an hour in 1999. Meanwhile the consumer price index (CPI) rises from 100 in 1993 (the base year) to 120 in 1999 (the current year). How much is your real hourly wage in 1999, and by what percentage has it increased since 1993 Money wages (current year) Real wage (current year) = X 100 CPI (current year) $8.40 = X 100 120 = $.07 X 100 = $7.00 Change $2 Percentage change = = Original number $5 29-24 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Real Wages versus Nominal Wages Problem: Your wage rate rises from $5 an hour in 1993 to $8.40 an hour in 1999. Meanwhile the consumer price index (CPI) rises from 100 in 1993 (the base year) to 120 in 1999 (the current year). How much is your real hourly wage in 1999, and by what percentage has it increased since 1993 Money wages (current year) Real wage (current year) = X 100 CPI (current year) $8.40 = X 100 120 = $.07 X 100 = $7.00 Change $2 Percentage change = = = .04 = 40% increase Original number $5 28-25 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Real Wages versus Nominal Wages Problem: Ms. Klopman has been working at the same job since 1989, the base year. She was making $400 a week at that time, and now, in 1999, she is earning $540 a week. If the CPI rose to 180 to 1999 , how much are Ms. Klopman’s real wages in 1999 and by what percentage did they change? 28-26 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Real Wages versus Nominal Wages Problem: Ms. Klopman has been working at the same job since 1989, the base year. She was making $400 a week at that time, and now, in 1999, she is earning $540 a week. If the CPI rose to 180 to 1999, how much are Ms. Klopman’s real wages in 1999 and by what percentage did they change? Money wages (current year) Real wage (current year) = X 100 CPI (current year) $540 = X 100 180 = $3 X 100 = $300 Change $100 Percentage change = = = .25 = 25% decrease Original number $400 28-27 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

The real wage now is below the level in the late 1970s Index of Real Wages, 1975-2001 (Base: Second Quarter of 1989 = 100) Bureau of Labor Statistics The real wage now is below the level in the late 1970s 28-28 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

The Minimum Hourly Wage Rate The Fair Labor Standards Act of 1938 Called for a 25 cent an hour minimum wage This was raised to 30 cents in 1939 Called for a standard workweek of 44 hours Reduced to 40 hours in 1940 Called for the payment of time and a half for overtime Twenty-five cents in 1938 would buy approximately $3 worth of goods and services today Minimum wage 1990 it was raised from $3.35 to $4.25 1996 it was raised to $4.75 1997 it was raised to $5.15 28-29 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

The Minimum Wage and the Unemployment Rate Monthly Unemployment Rate, 1996, 1997, and 1998 / 1996 1997 1998 January 5.7 5.3 4.7 February 5.5 5.3 4.6 March 5.7 5.2 4.7 April 5.5 5.0 4.3 May 5.5 4.8 4.4 June 5.3 5.0 4.5 July 5.4 4.9 4.5 August 5.2 4.9 4.5 September 5.2 4.9 4.5 October 5.2 4.8 4.5 November 5.3 4.6 4.4 December 5.3 4.7 4.4 Green indicates minimum wage increase in that particular month and year 28-30 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Should There Be a Minimum Wage Rate? Conservatives say the minimum wage law hurts the very people it is supposed to help They claim the basic effect of the minimum wage is to cause millions of marginal workers to be unemployed They point to rising teenage unemployment as proof 28-31 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Should There Be a Minimum Wage Rate? Who earns the minimum wage rate? In 2003 nearly 3 million Americans did Two-thirds were adults Most of the rest were teenage members of low-income families for whom the wages were an important source of income 28-32 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Should There Be a Minimum Wage Rate? Who in America can live on $5.15 an hour? Who in America is worth less than $5.15 an hour? 28-33 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

The Living Wage The living wage is a minimum hourly wage that must be paid to employees of major contractors doing business with over 100 municipalities Only about 150,000 workers are covered nationwide In most cases the stipulated hourly rate is between $7.50 and $10.00 and hour 28-34 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Last Word Labor unions have raised wages of their members by restricting the supply of labor The minimum wage and the living wage laws have placed a floor under wages These are two instances of interference with the functioning of the market forces of supply and demand At best, about 20 percent of our labor force is affected by unions, the minimum wage, or the living wage The bottom line remains that the wage rate is determined by supply and demand 28-35 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.