Income Inequality © 2003 South-Western/Thomson Learning

Why Do Wages Differ? An Imaginary WorldAn Imaginary World Compensating DifferentialsCompensating Differentials Differences in AbilityDifferences in Ability Barriers to EntryBarriers to Entry Union Wage SettingUnion Wage Setting

An Imaginary World Imagine an unreal world with three features: except for differences in wages, all jobs are equally attractive to all workersexcept for differences in wages, all jobs are equally attractive to all workers all workers are equally able to do any joball workers are equally able to do any job all labor markets are perfectly competitiveall labor markets are perfectly competitive

An Imaginary World aa a Number of Executive Assistants Hourly Wage 20 $26 L D L 2 S L 1 S Number of Carpenters Hourly Wage $30 26 L D L 1 S L 2 S A' A (a) B (b) B'

Why Do Wages Differ? Compensating Wage Differential A difference in wages that makes two jobs equally attractive to a worker

Why Do Wages Differ? Nonmonetary job characteristics give rise to compensating wage differentials.Nonmonetary job characteristics give rise to compensating wage differentials. Jobs considered intrinsically less attractive will tend to pay higher wages, other things being equal.Jobs considered intrinsically less attractive will tend to pay higher wages, other things being equal.

Why Do Wages Differ? Cost of Living Differences Can cause compensating wage differentials

Why Do Wages Differ? Differences in Human Capital Differences in human capital requirements can cause compensating wage differentials.

Why Do Wages Differ? Differences in Ability Those with greater talent, intelligence, or perseverance will be more productive and generate more revenue for firms, so firms will be willing to pay them a higher wage.

Barriers to Entry In some labor markets, barriers (e.g., occupational licensing laws) keep out would-be entrants, resulting in higher wages in those markets.

Union Wage Setting Through an increase in member wages and a decrease in nonmember wages, unions create a wage differential between union and nonunion markets.

Union Wage Setting aa a aa a Number of Long-Haul Truckers Wage W 1 W 2 (a) L D L S 250, , ,000 Number of Short-Haul Truckers Wage W 3 W 1 L D 200, ,000 L S 1 L 2 S A' A (b) B B'

Discrimination and Wages Employer PrejudiceEmployer Prejudice Employee and Customer PrejudiceEmployee and Customer Prejudice Statistical DiscriminationStatistical Discrimination Dealing with DiscriminationDealing with Discrimination Discrimination and Wage DifferentialsDiscrimination and Wage Differentials

Discrimination When a group of people have different opportunities because of personal characteristics that have nothing to do with their abilities

Employer Prejudice When prejudice originates with employers, market forces work to discourage discrimination and reduce or eliminate any wage gap.

Employer Prejudice Number of Workers Wage W 1 W 3 L D Sector A (Discriminating) Number of Workers Wage W 2 W 1 Sector B (Nondiscriminating) L D L 1 S L 2 S L 2 S L 1 S

Employee and Customer Prejudice When prejudice originates with the firm’s employees or its customers, market forces encourage discrimination and can lead to a permanent wage gap.

Statistical Discrimination When individuals are excluded from an activity based on the statistical probability of behavior in their group

Dealing with Discrimination Pure employer discrimination has little impact on labor marketsPure employer discrimination has little impact on labor markets Some types of discrimination need government actionSome types of discrimination need government action –affirmative action programs –stricter enforcement of existing laws –stiffer penalties for breaking the laws

Discrimination and Wage Differentials % White MedianMale (Weekly) Income Income White males$748100% Black males Hispanic Males White females Black females Hispanic females Source: BLS, 2001, 3rd quarter

Vicious Cycle of Discrimination Current Job Discrimination Lower Wage Lower Human Capital Investment Unemployment Lower Skill Level Less Job Experience Pre-Market Discrimination

Measuring Income Inequality The Poverty RateThe Poverty Rate The Lorenz CurveThe Lorenz Curve Problems with Inequality MeasuresProblems with Inequality Measures

Nonlabor Income Property IncomeProperty Income –income from supplying capital, land, or natural resources Transfer PaymentTransfer Payment –payment that is not compensation for supplying goods or services

The Poverty Rate Poverty Rate The percent of families whose incomes fall below a certain minimum - the poverty line

The Poverty Rate Poverty Line The income level below which a family is considered to be in poverty

The Lorenz Curve Lorenz Curve When households are arrayed according to their incomes, a line showing the cumulative percent of income received by each cumulative percent of households

The Lorenz Curve Gini Coefficient A measure of income inequality; the ratio of the area above a Lorenz curve and under the complete equality line to the area under the diagonal

The U.S. Lorenz Curve Percentage of Households Percentage of Total Income A B Line of Complete Equality Lorenz Curve

U.S. Lorenz Curves for Income and Wealth Percentage of Households Percentage of Total Income or Wealth Line of Complete Equality Income Wealth

Problems with Inequality Measures Earned Income Versus Available IncomeEarned Income Versus Available Income Income MobilityIncome Mobility Careless InterpretationsCareless Interpretations

Income Inequality, Fairness, and Economics Inequality that results from choices that any of us can make is generally regarded as fair.

Income Inequality, Fairness, and Economics aa a Number of Workers Hourly Wage L D 3.00 $4.00 L 1 S L 2 S (c) Unskilled Labor Not Covered by Law Number of Workers Hourly Wage L D 4.00 $5.15 L S N 2 N 1 N 3 (b) Unskilled Labor Covered by Law Number of Workers Hourly Wage L S $24.00 L 2 D L 1 D (a) Skilled Labor