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 four 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 affect  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.

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 interest, dividends, rents profits

Answer  So what will you be making 6 years after HS per year?  Name some high paying careers?  What education level does each require?

Answer  What do you think ---?  Half sheet of paper  Name  Highest level of education attained within 6 years after HS.  Anticipated 1 year earnings  What will justify you being paid that amount?

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

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.  Over the last 5 years, real wages for the lowest 70% of educated in US

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

GDP  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

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 and 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

 Book page 273 figure 14.1  Output is increasing  Compensation not keeping pace  WHY?  Research: Start with Huffington Report Wages aren’t keeping up with US Productivity

Real Wages and Productivity

 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  A person provides  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  Influences on the Supply of Labor  Three key factors influence the supply of labor: Adult population 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.

 So, why don’t more Americans get a college degree or higher?  75% to 80% graduation rate from HS  55% go to college  63% graduate in 6 years or less (26 to 28 graduate)  Nationally, 30% of adults > age 30 have college degrees  OR 70% do not have a college degree

 US has fallen behind some notations 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

 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, according to the left-leaning Economic Policy Institute, which crunched the numbers last year.

Market Demand for Labor

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.

Real Wages and Productivity LO

 In the previous two slides,  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

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 13-56

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

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

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 13-66

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

Wage Differentials 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

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

 (Last Word) Have the students prepare and conduct a debate on whether CEOs  (as well as superstars in the sports and entertainment industry) are overpaid.