13 Wage Determination McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. 14

Goals  Differentiate between nominal and real wages.  List those factors that have led to an increasing level of real wages in the U.S. historically.  Non necessarily in the last eight years  Determine the equilibrium wage rate  employment level when given appropriate data for a firm operating in a purely competitive

Chapter Goals  Illustrate graphically how wage rates are determined in  purely competitive  monopolistic labor markets.  List the methods used by labor organizations  to increase wages  and the impact each has on employment.

Chapter goals  Illustrate graphically how an inclusive (industrial) union and an exclusive (craft) union would impact  wages and employment in a previously competitive labor market.  Explain and illustrate graphically wage determination  In the bilateral monopoly model.  Present the major points in the cases for and against the minimum wage.

Chapter Goals  Explain the demand factors that create wage differentials. Explain the supply factors that create wage differentials.  Describe briefly salary systems in which pay is linked to performance rather than to time.  Describe the negative side effects of poorly planned incentive pay plans.  Define and identify terms and concepts listed at the end of the chapter.

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. What Do You Want In Life?

 I’ll tell ya what I want I’ll tell ya what I want

Standard Of Living What is it? Per Investopedia – The level of wealth, comfort, material goods and necessities available to a certain socioeconomic class in a certain geographic area. – The standard of living includes factors such as income, quality and availability of employment, class disparity, poverty rate, quality and affordability of housing, hours of work required to purchase necessities, gross domestic product, inflation rate, number of vacation days per year, – The standard of living is closely related to quality of life.

What Do You Want?  Answer: Full sheet of paper  1. What standard of living do you want for yourself?  Better, the same or worse than your parents?  2. WHY?

Income  What is income?  The money a person receives in exchange for work or use of property  Many sources  Assets  Work done Labor wages make up 70% of all total income 30% from Assets: interest, dividends, rents profits

Answer  3. Highest level of education attained within 6 years after HS.  4. Name some high paying careers?  5. What education level does each require?

Answer  6. So what will you be making 6 years after HS per year?  7. Key answer: What will justify you being paid that amount?

 All of this from the previous slide are related to Income  quality and availability of employment, class disparity, poverty rate, quality and affordability of housing, hours of work required to purchase necessities, gross domestic product, inflation rate, number of vacation days per year,

Highest Paid Careers  Doctors’ salaries are so high not only because of supply and demand but also to offset the amounts they have to invest in education and malpractice insurance. The 33,310 anesthesiologists in the U.S. also work long shifts and play an integral role in keeping patients alive during surgery to earn their sizable salaries. The high pay reflects the responsibility and risk involved in their job.

Top Paying Careers In US  Top paying careers Top paying careers  Myplan.com top paying careers

Lowest Paid Work  The lowest-paid workers, fast food cooks, earn $9 an hour, for an average annual salary of $18,720. More than a half million people in the U.S. hold this position, and another 2.8 million are in a food preparation and serving job, the second worst-paying occupation. Dishwashers and shampooers trail close behind, making a meager $18,840 and $19,130 a year, respectively.

 So how do you make depends in large part on---  Almost all are related to education

Life Is Not Fair  Get used to it!!!  Only about 25% to 30% of students graduating today will earn a college degree (in 6 years)  30% ± drop out of HS  0f those 70± remaining, 60% go to college (42 students)  Of those, 40±% do not finish in 6 years Some go back as adults to start/finish National Center For Education Statistics

To be sure, the recession has hit unevenly, with lower-skilled and less-educated Americans feeling the pinch the most, says Mark Zandi, chief economist for Moody's Economy.com based in West Chester, Pa. Many found their jobs gone for good as companies moved production offshore or bought equipment that replaced manpower.Mark ZandiMoody's Economy.comWest Chester "The pace of change has been incredibly rapid and incredibly tough on the less educated," says Mr. Zandi, who calls this period the most difficult for American households since the 1930s. "If you don't have the education and you don't have the right skills, then you are getting creamed."

 The case of Fulton Boiler

 Education does not necessarily mean college  Engineering degree vs. Liberal Arts degree  Certified Automotive mechanic vs. High School Education

Your competition  Not just next to you  We are in a global economy  You competition is also overseas

China: World's Largest Supplier Of Educated Workers By 2030, China alone will account for 30 percent of the world's new college-educated workers, predicts a study by the McKinsey Global Institute. In comparison, the United States will account for only 5 percent, and collectively, advanced countries including the U.S., Japan and much of Europe will account for only 14 percent of new highly educated workers.

 "Investments in education that China made much earlier are now paying off," said Anu Madgavkar, a senior fellow for the McKinsey Global Institute. "China invested in opening a lot of schools and they ramped up college enrollment.“

 China is also churning out far more science, technology, engineering and mathematics grads, giving it a leg up in some of the world's fastest growing sectors.  In 2008, only 14 percent of U.S. grads earned degrees in those specialties, whereas 42% of China's college grads did so.

What Decisions Are You Making?  What decisions are you making for yourself?

Elements To Higher Wages  Education  The “right” education  Skills  Hard work  Supply and demand for a particular position  None of these are a guarantee for high wages

Apply Supply & Demand To Wages  What happens---  Why can you work in the Perdoe Bay and make $100,000 a year or more?  Why can you move to North Dakota an make $100,000 without a college degree  Why do Walmart workers barely make mimimum wage?

 Unemployment rates impact wages  Why or how?  Graph any job using Supply and Demand High unemployment Low unemployment

Labor, Wages,and Earnings  Wages  Price paid for labor  Direct pay plus fringe benefits  Wage rate  Price per unit paid

Labor, Wages,and Earnings  Nominal wage  Amount of money received per hour  Real wage  Quantity of goods or services a worker can purchase  With a nominal wage

Wages  Real wages only increase if nominal wages increase faster than the inflation rate.  If prices increase faster than nominal wages, real wages will fall.  This has happened for last 5+ years  Over the last 5 years, real wages for the lowest 70% of educated in US  Have fallen!!!

Wages And Employment  For most, labor market is only source of income  We work and earn a wage But: What determines the amount of labor we supply? What determines the amount of wages will be paid?

Role Of Productivity  Demand for labor (or any resource) depends on productivity  Generally  The greater the productivity of labor  The greater the demand for labor

Role Of Productivity  Demand for labor in advanced economies is large  Because labor is highly productive

Real Wages and Productivity  Generally a close relationship  Real income and real output are two ways of looking at the same thing  Per worker compensation can only increase  At about same rate as productivity or output per worker

Gross Domestic Product  The market value of all officially recognized final goods and services produced  within a country  in a given period of time.  GDP per capita is often considered an indicator of a country's standard of living  GDP per capita is not a measure of personal income

 Under economic theory,  GDP per capita exactly equals the gross domestic income per capita

Productivity  Look at productivity factors  You are late = you are not as productive as someone on time  Examine personal productivity

Role Of Productivity  Plentiful capital  Access to abundant natural resources  Advanced technology  Labor quality  Other factors

Role Of Productivity  Plentiful capital  Physical  Money  Access to natural resources  Available in large quantities  In relation to labor force  Advanced technology  Available capital is also advanced

Role Of Productivity  Labor quality  Healthy  Vigorous (motivated)  Educated  High quality training  Therefore, tend to be efficient

 Other factors  Efficiency of management  Business  Social and political environment  Increased specialization

Real Wages and Productivity  Generally a close relationship  Real income and real output are two ways of looking at the same thing  Per worker compensation can only increase  At about same rate as productivity or output per worker

Real Wages and Productivity  Real world, suppliers of  land,  capital  talent also share in profits (today; disproportional)  Therefore, real wages do not always rise the same as productivity Over short periods of time  Over long term, productivity and real wages tend to rise together

Productivity  Write: Answer  What makes you personally productive?  What would make you a more productive citizen?

 Unemployment rates impact wages  Why or how?  Graph any job using Supply and Demand High unemployment Low unemployment

 Output is increasing  Compensation not keeping pace  WHY? Where are the increases in productivity (money) going?  We are now going full circle to the beginning of the year  Research: Start with Huffington Report Wages aren’t keeping up with US Productivity

Real Wages and Productivity LO

20% of the people control 92% of the wealth in the United States

Productivity  Answer  What makes you personally productive?  What would make you a more productive citizen?

Real Wages and Productivity  History repeats itself

 Ford Motor Company made headlines in 1914 by offering autoworkers $5 per day, up from $2.50 per day. The wage payment was newsworthy because the typical market wage in manufacturing at that time was just $2 to $3 per day.   What was Ford’s rationale for offering a higher-than-competitive wage? Statistics indicate that the firm was suffering from high rates of job quitting and absenteeism. It reasoned that a high wage rate would increase worker productivity by increasing morale and reducing employment turnover. Only workers who worked at Ford for at least six months were eligible for the $5 per day wage. Nevertheless, 10,000 workers sought jobs with Ford in the immediate period following the announcement of the wage increase.   According to historians, the Ford strategy succeeded. The $5 wage raised the value of the job to Ford workers. That created worker incentives to maintain employment at Ford and show up for work each day. It also encouraged laborers to work energetically so as not to be fired from a job that paid much more than alternative employment. The rates of job quitting and absenteeism both plummeted, and labor productivity at Ford rose by an estimated 51 percent that year.   The $5 wage was an efficiency wage—one that raised the marginal revenue product of Ford workers. Ford’s pay plan addressed its principal-agent problem. The $2.50 wage hike “paid for itself” by more closely aligning the interests of Ford workers and owners.   1 This application is from Campbell R. McConnell, Stanley L. Brue, and David A. Macpherson, Contemporary Labor Economics, 5th ed. (New York: McGraw-Hill, 1999), p It is based in part on Daniel M. G. Raff and Lawrence Summers, “Did Henry Ford Pay Efficiency Wages?” Journal of Labor Economics, pt. 2, October 1987, pp. S57-S86.

 Barely a week after coming out in favor of increasing the federal minimum wage to $10.10, Costco CEO Craig Jelinek reported that his company posted profits of $537 million for the last quarter. That’s up from $394 million last year. “At Costco,” Jelinek said, “we know that paying employees good wages makes good sense for business.” He went on to elaborate that “We know it’s a lot more profitable in the long term to minimize employee turnover and maximize employee productivity, commitment and loyalty.”

Supply Of Labor  People supply labor to earn income  Many factors influence the quantity of labor  What a person provides Knowledge Motivation Creativity Skills  KEY factor is wage rate

WAGES AND EMPLOYMENT  The Supply of Labor  People supply labor to earn an income.  Many factors influence the quantity of labor that a person plans to provide, but the wage rate is a key factor.  Figure on the next slide shows an individual’s labor supply curve.

WAGES AND EMPLOYMENT The table shows Larry’s labor supply schedule, which is plotted in the figure as Larry’s labor supply curve.

 Productivity, which measures the goods and services generated per hour worked  Rose by 80.4% between 1973 and 2011  Compared to a 10.7% growth in median hourly compensation  This factors ALL compensation  Rose more for educated workers

WAGES AND EMPLOYMENT  Influences on the Supply of Labor  Three key factors influence the supply of labor: Wages Current Expected future Adult population (willing to work) Preferences Time in school Training

WAGES AND EMPLOYMENT  Adult Population  An increase in the adult population increases the supply of labor.  Preferences  There has been a large increase in the supply of female labor since  The percentage of men with jobs has shrunk slightly.

WAGES AND EMPLOYMENT  Time in School and Training  The more people who remain in school for full- time education and training, the smaller is the supply of low-skilled labor.

 US has fallen behind some nations in its college educated population  What does this mean for the US economy?  What will happen to US wages and the difference between the people with money and the people without money?

Global Perspective LO

WAGES AND EMPLOYMENT The table shows Larry’s labor supply schedule, which is plotted in the figure as Larry’s labor supply curve.

WAGES AND EMPLOYMENT 1. At a wage rate of $10.50 an hour, Larry … 2. …supplies 30 hours of labor a week.

WAGES AND EMPLOYMENT 5. …reaches a maximum, … 4. …increases, 3. As the wage rate rises, Larry’s quantity of labor supplied … 6. …then decreases.

WAGES AND EMPLOYMENT This supply curve shows how the quantity of car wash workers supplied changes when the wage rate changes, other things remaining the same.

WAGES AND EMPLOYMENT In a market for a specific type of labor, the quantity supplied increases as the wage rate increases, other things remaining the same.

Minimum Wage  What is minimum wage?  Is minimum wage free market? Why or why not?  Should we have a minimum wage?

Real Wages and Productivity LO

 What factors do you think are contributing to wages going down and productivity is going up?

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 LO

Inflation and Real Wage Increases  If inflation runs at 2%  Wage increases are 3%  Real wage increases are 1%  Increase in purchasing power  If inflation is 3%  Wage increases are 2%  Real wages increases are a negative 1%  Loss of buying power

Real Wages and Productivity  Long-run trend of average real wages in the U.S. Real Wage Rate (Dollars) Quantity of Labor D 1900 S 1900 D 1950 D 2000 D 2020 S 1950 S 2000 S 2020 LO

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 LO

($10) W C ($10) W C Wage Rate (Dollars) Labor Market Quantity of Labor Wage Rate (Dollars) Individual Firm Quantity of Labor QCQC (1000) 00 d=mrp qCqC (5) s=MRC Competitive Labor Market LO2 D=MRP (∑ mrp’s) S e b a c 13-86

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 LO

Examples of monopsony power Monopsony Model Wage Rate (Dollars) Quantity of Labor 0 S MRP MRC c b a WcWc WmWm QmQm QcQc LO

Monopsony Power  Maximize profit by hiring smaller number of workers  Examples of monopsony power  Nurses  Professional Athletes  Teachers  Three union models LO

Demand Enhancement Model  Union model  Increase product demand  Alter price of other inputs Wage Rate (Dollars) Quantity of Labor WuWu QcQc QuQu WcWc D1D1 D2D2 S Increase In Demand LO

Craft Union Model  Effectively reduce supply of labor  Restrict immigration  Reduce child labor  Compulsory retirement  Shorter workweek  Exclusive unionism  Occupational licensing LO

Wage Rate (Dollars) Quantity of Labor D S1S1 QcQc WcWc S2S2 WuWu QuQu Decrease In Supply Craft Union Model LO

Industrial Union Model  Inclusive unionism  Auto and steel workers Wage Rate (Dollars) Quantity of Labor D S QcQc WcWc WuWu QuQu QeQe a b e LO

 Test

Topics Remaining Ch. 14  Unions  Wages and unemployment  Minimum wage controversy  Types of wages

Unions  In most cases, workers compete openly with each other for compensation  With unions, this is not the case

Unions Defined  An association, combination, or organization of employees who (in theory) band together to secure  Favorable wages  Improved working conditions  Better work hours  Resolve grievances against employers.

Advantages of Unions  Higher wages  Generally health care or better health care  Pay less out of pocket for healthcare  More vacation time/days off/paid leave  Reduce wage inequity (except at NSD)  Generally help raise non union wages in industry  More job security  Generally better benefits

Advantages of Unions  More job security  Generally better benefits  Do not negotiate wages or raises for yourself

Disadvantages of Unions  Disadvantages are low compared to benefits  However, if negotiations do not end in agreement a strike may take place  “Hard working” or “ambitious” employees are paid same as “lazy” employees  Could have incompetent or negligent negotiators  That have their own agenda

Disadvantages of Unions  Can create us vs. them (management) work environment  Often impede progress  Especially if workforce reduction results  Loss of individuality  Non “right to work” states  Employee MUST belong to union to work  MUST support the union financially

Disadvantages of Unions  Can be fined or otherwise disciplined by their union  for engaging in activities, which, the union's deems Are "unbecoming" of union members Or which violate the union's constitution and by- laws.  Examples of such activities may include crossing a picket line during a strike, exceeding production quotas, or seeking to be represented by a different union.

Union Models  Three Union models  Demand Enhancement Model  Exclusive or craft union model  Inclusive or industrial model

Demand - Enhancement Model  Most desirable technique for raising wages  Components  Increase demand  Increase productivity  Alter price of other inputs

 Increase demand for labor  By raising demand for a product Advertising Political Lobbying  Buy union made goods used to be an American advertising tag line to many products

Demand Enhancement Model  Union model  Increase product demand  Alter price of other inputs Wage Rate (Dollars) Quantity of Labor WuWu QcQc QuQu WcWc D1D1 D2D2 S Increase In Demand LO

Demand Enhancement  Q. Why would a union fight a companies attempts to increase productivity?  Example” through use of robots  A: Increases in productivity could mean less union workers needed.

Increase Productivity  Generally management makes decisions  Unions want a say  Often are brought in to get “buy in”  Can sometimes mean the difference between some jobs or no jobs  Ford factory in Brazil not US

Craft Union Model  Effectively reduce supply of labor  Restrict immigration  Reduce child labor  Compulsory retirement  Shorter workweek  Exclusive unionism  Occupational licensing LO

Wage Rate (Dollars) Quantity of Labor D S1S1 QcQc WcWc S2S2 WuWu QuQu Decrease In Supply Craft Union Model LO

Inclusive or Industrial Union Model  Attempt to unionize all workers  Auto and steel trucking  Can put immense pressure on industry  Can strike en mass Teamsters in the 60’s Transit in Philadelphia 40’s

Industrial Union Model  Inclusive unionism  Auto and steel workers Wage Rate (Dollars) Quantity of Labor D S QcQc WcWc WuWu QuQu QeQe a b e LO

Craft Union Model  Effectively reduce supply of labor  Restrict immigration  Reduce child labor  Compulsory retirement  Shorter workweek  Exclusive unionism  Occupational licensing LO

Union Models  Are unions successful?  Wages 15% higher on average  Consequences:  Higher unemployment  Restricted ability to demand higher wages LO

 US participation peaked in 60’s at 30+%  Now sits at 11% ± and is declining  Most union members are now in public sector  Philadelphia and New York are two strongholds

Answer  Given these factors, why do you think the economic impact of unions is diminished and the number of workers covered by unions has been shrinking since the 1940’s?

Bilateral Monopoly Model  Monopsony and inclusive unionism  Single buyer and seller  Not uncommon  Indeterminate outcome  Desirability LO

Bilateral Monopoly Model LO4 Wage Rate (Dollars) Quantity of Labor D=MRP S QcQc WcWc WuWu Q u =Q m MRC WmWm a

The Minimum Wage Controversy  Case against minimum wage  Case for minimum wage  State and locally set rates  Evidence and conclusions LO

Minimum Wage  Current minimum wage  $7.25 per hour  Tend to be industries that make only a few cents per dollar profit  Generally young workers

Research  What are five reasons to raise minimum wage?  What are five reasons to NOT raise minimum wage?  What is your opinion and WHY?

Wage Differentials  Difference between wages paid

Wage Differentials LO

Wage Differentials  Workers prevented from moving to higher paying jobs  Market imperfections  Lack of job information  Geographic immobility  Unions and government restraints  Discrimination LO

Wage Differentials SaSa DaDa SbSb DbDb ScSc DcDc SdSd DdDd W W W W Q QQ Q WaWa WbWb WcWc WdWd QaQa QbQb QcQc QdQd (a) (b) (c) (d) LO

Wage Differentials  Differences across occupations  What explains wage differentials?  Marginal revenue productivity  Noncompeting groups  Ability  Education and training  Compensating differences LO

Wage Differentials LO

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 LO

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 LO

 Prepare (Max 2 pages – MLA format)  on whether CEOs as well as superstars in the sports and entertainment industry are overpaid.  Hand in at 8:00  Debate last 15 minutes