What causes earnings to vary so much? Wages are governed by labor supply and labor demand. Labor demand reflects the marginal productivity of labor. 3

What causes earnings to vary so much? In equilibrium, each worker is paid the value of his or her marginal contribution to the production of goods and services. 3

Some Determinants of Equilibrium Wages Compensating differentials Human capital Ability, effort, and chance Signaling The superstar phenomenon Other 4

Compensating Differentials Compensating differentials refer to differences in wages that arises from nonmonetary characteristics of different jobs. ä Coal miners are paid more than others with similar levels of education. ä Night shift workers are paid more than day shift workers. 5

Human Capital Human capital is the accumulation of investments in people. The most important type of human capital is education. 6

Human Capital College graduates in the U.S. earn about 65 percent more than workers with a high school diploma. 6

Ability, Effort, and Chance Ability: Because of heredity and upbringing, people differ in their physical and mental attributes. 7

Ability, Effort, and Chance Effort: Some people work hard, others are lazy—those that work hard are more productive and earn more. 7

Ability, Effort, and Chance Chance: Being in the right place at the right time; learning the right skills. 7

Signaling – An Alternative View of Education Firms use educational attainment as a way of sorting between high-ability and low-ability workers. ä It is rational for firms to interpret a college degree as a signal of ability. 8

The Superstar Phenomenon Superstars arise in markets that exhibit the following characteristics: ä Every customer wants to enjoy the good supplied by the best producer. ä The good is produced with a technology that makes it possible for the best producer to supply every customer at a low cost. 9

Quick Quiz! Give two reasons why more-educated workers earn more than less-educated workers. 16

Market Imperfections Lack of Market Information Labor immobility Union and Gov’t Restrictions Union cards, health insurance, tenure Discrimination 10

The Economics of Discrimination Discrimination is another source of wage differences. ä Discrimination occurs when the marketplace offers different opportunities to similar individuals who differ only by race, ethnic group, sex, age, or other personal characteristics. 10

The Economics of Discrimination The differences in earnings caused by discrimination are viewed as unjust and socially unacceptable. 10

Measuring Labor-Market Discrimination Discrimination is often measured by looking at the average wages of different groups. 11

Measuring Labor-Market Discrimination Even in a labor market free of discrimination, different people have different wages. Measuring the amount of discrimination is difficult because some difference in wages is due to differences in education and job characteristics. 11

Discrimination by Customers and Governments Discrimination can persist in competitive markets under the following conditions: ä When customers are willing to pay to maintain the discriminatory practice. ä When the government requires firms to discriminate. 15

Here are the 10 skills employers say they seek, in order of importance Here are the 10 skills employers say they seek, in order of importance. (Forbes) Ability to work in a team structure Ability to make decisions and solve problems Ability to communicate verbally with people Ability to plan, organize and prioritize work Ability to obtain and process information Ability to analyze quantitative data Technical knowledge related to the job Proficiency with computer software programs Ability to create and/or edit written reports Ability to sell and influence others 15

Oddest employee complaints about co-workers (Chicago Tribune) Employee is too sun-tanned. Employee has big hair. Employee eats all the good cookies. Employee has bells on her shoes, and it's not the holidays. Employee is too polite. Employee suspected co-worker is a pimp. Employee breathes too loudly. Co-worker reminded the employee too much of Bambi. 10

Principal-Agent Problem Pay-for-performance Incentive pay plan Piece rates Commissions or royalties Bonuses - stock options/profit sharing Efficiency Wages Negative side-effects

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 Unresolved

The Debate Over Comparable Worth According to the doctrine of comparable worth, jobs deemed comparable should be paid the same wage. 16

The Debate Over Comparable Worth Advocates of comparable worth want jobs to be rated according to a set of impartial criteria such as education, experience, and so on. 16

The Debate Over Comparable Worth Critics of comparable worth argue that a competitive market is the best mechanism for setting wages. 16

Conclusion In competitive markets there are many things that affect the value of the marginal product of labor. The theory of wage determination simply explains why some workers earn higher wages than other workers. Market Imperfections Principal-Agent Problem 17