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Slides by John F. Hall Animations by Anthony Zambelli INTRODUCTION TO ECONOMICS 2e / LIEBERMAN & HALL CHAPTER 9 / THE LABOR MARKET AND WAGE RATES ©2005,

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Presentation on theme: "Slides by John F. Hall Animations by Anthony Zambelli INTRODUCTION TO ECONOMICS 2e / LIEBERMAN & HALL CHAPTER 9 / THE LABOR MARKET AND WAGE RATES ©2005,"— Presentation transcript:

1 Slides by John F. Hall Animations by Anthony Zambelli INTRODUCTION TO ECONOMICS 2e / LIEBERMAN & HALL CHAPTER 9 / THE LABOR MARKET AND WAGE RATES ©2005, South-Western/Thomson Learning Chapter 9 The Labor Market and Wage Rates

2 Lieberman & Hall; Introduction to Economics, 2005 2 Labor Markets In Perspective Labor Markets differ in an important way from the other markets we’ve considered so far in this book  Firms need resources to make goods and services We can identify three general categories of resource markets  Markets for capital  Markets for land  Markets for labor Labor is different from other things that are traded  Sellers of labor care about factors in the work place Another feature of labor is the meaning of the price in this market  Wage rate

3 Lieberman & Hall; Introduction to Economics, 2005 3 Figure 1: Product and Factor Markets HouseholdsFirms S D Demand for Goods and Services Supply of Goods and Services Demand for Resources Supply of Resources Factor Markets Product Markets S D

4 Lieberman & Hall; Introduction to Economics, 2005 4 Defining a Labor Market How broadly or narrowly we define a market depends on the specific questions we wish to answer  Broadly defined markets may look at markets that draw on labor from all over the world  Narrowly defined markets may look at markets that draw on labor on a very localized level

5 Lieberman & Hall; Introduction to Economics, 2005 5 Competitive Labor Markets Market with many indistinguishable sellers of labor and many buyers  Involves no barriers to entry or exit  Perfectly competitive labor markets must satisfy three conditions Great many buyers (firms) and sellers (households) of labor in market All workers in market appear the same to firms No barriers to entering or leaving labor market

6 Lieberman & Hall; Introduction to Economics, 2005 6 Competitive Labor Markets and The Equilibrium Wage Wage rate determined like the price of other competitive markets:  Supply and demand The labor demand curve in any labor market slopes downward because a rise in the wage rate  1) increases firms’ costs, causing them to decrease production and employ fewer workers  2) increases the relative cost of labor from that market, causing firms to substitute other inputs, such as capital or other types of labor The labor supply curve in any labor market slopes upward because a rise in the wage rate  1) induces some of those not currently working to seek work  2) attracts some of those who are currently working in other labor markets The forces of supply and demand will drive a competitive labor market to its equilibrium point—the point where the labor supply and labor demand curves intersect

7 Lieberman & Hall; Introduction to Economics, 2005 7 Figure 2: A Competitive Labor Market Number of Workers Hourly Wage LDLD $12 LSLS 10,000

8 Lieberman & Hall; Introduction to Economics, 2005 8 Why Do Wages Differ? Significant inequality exists in wage rates  Among different occupations  Among and within occupations in U.S. labor market Wage inequality is persistent Both highest and lowest paid occupations have been so for decades

9 Lieberman & Hall; Introduction to Economics, 2005 9 Nonmonetary Job Characteristics When evaluating a career, whether you are aware of it or not, you are evaluating hundreds of nonmonetary job characteristics, including  Risk of death or injury  Cleanliness of work environment  Prestige you can expect in your community  Amount of physical exertion required  Degree of intellectual stimulation  Potential of advancement

10 Lieberman & Hall; Introduction to Economics, 2005 10 Nonmonetary Job Characteristics You will also think about geographic location of job and characteristics of the community in which you would live and work  Weather  Crime rates  Pollution levels  Transportation system  Cultural amenities Nonmonetary characteristics of different jobs give rise to compensating wage differentials  Jobs considered intrinsically less attractive will tend to pay higher wages, other things being equal

11 Lieberman & Hall; Introduction to Economics, 2005 11 Nonmonetary Job Characteristics What about unusually attractive jobs?  These jobs will generally pay negative compensating differentials Different people have different tastes for working and living conditions Cannot use our own preferences to declare a job as less attractive or more attractive  Or to decide which jobs should pay a positive or negative compensating differential Rather, when labor markets are perfectly competitive  Entry and exit of workers automatically determines compensating wage differential in each labor market

12 Lieberman & Hall; Introduction to Economics, 2005 12 Nonmonetary Job Characteristics Compensating wage differentials are one reason most economists are skeptical about idea of comparable worth  Holds that a government agency should determine skills required to perform different jobs and mandate wage differences needed between them Economists generally prefer policies to increase competition and eliminate discrimination  So that the market itself can determine comparable worth

13 Lieberman & Hall; Introduction to Economics, 2005 13 Cost of Living Differences Differences in living costs can cause compensating wage differentials  Areas where living costs are higher than average will tend to have higher than average wages To compensate for the higher cost of living

14 Lieberman & Hall; Introduction to Economics, 2005 14 Differences in Human Capital Requirements All else equal, jobs that require more education and training will be less attractive  In order to attract workers, these jobs must offer higher pay than other jobs that are similar in other ways, but require less training Differences in human capital requirements can give rise to compensating wage differentials  Jobs that require more costly training will tend to pay higher wages, other things equal Compensating differentials explain much of the wage differential between jobs requiring college degrees and requiring only a high school diploma The idea of compensating wage differentials dates back to Adam Smith  First observed that unpleasant jobs seem to pay more than other jobs that require similar skills and qualifications

15 Lieberman & Hall; Introduction to Economics, 2005 15 Differences In Ability Not everyone has the intelligence needed to perform well at any job Scientific discoveries and technological advances have increased not only skill requirements of many jobs  But also abilities needed to acquire those skills In general, those with greater ability to do a job well—based on their talent, intelligence, motivation, or perseverance— will be more valuable to firms  Firms will be willing to pay them a higher wage rate Beyond any compensating differential for their human capital investment

16 Lieberman & Hall; Introduction to Economics, 2005 16 The Economics of Superstars Why was owner of Texas Rangers willing to pay $25 million per year to have Alex Rodriguez play for his team?  Immediate answer Because Rodriguez is so good When we try to explain extremely high wage rates of these superstars based on their exceptional abilities alone, we confront a puzzle The very top writers, rock stars, comedians, talk-show hosts, and movie directors all earn wage premiums that seem vastly out of proportion to their additional abilities  Why? Explanation in all these cases is based on ability  And also by exaggerated rewards market bestows on those deemed the best or one of the best in a field

17 Lieberman & Hall; Introduction to Economics, 2005 17 The Economics of Superstars If most people rank recent mystery novels in the same order, then the best will sell millions of copies, second best will sell hundreds of thousands, and third best might sell only thousands  Even though all three novels might be very close in quality A publisher will earn ten times more revenue selling the best novel (compared to the second best), and ten times more revenue selling the second best (compared to the third best), and so on Same thing happens in markets for athletes, rock concerts, action movies, and news broadcasters  But phenomenon is not limited to media markets or media stars

18 Lieberman & Hall; Introduction to Economics, 2005 18 Using The Theory: The Minimum Wage Minimum wage law…makes it illegal to hire a worker for less than a specified wage  In any labor market covered by the law Most people think about the minimum wage as a means to increase living standards for the lowest paid workers, and their analysis stops there But minimum wage creates a wage differential among the least-skilled workers, depending on the industry in which they work  By raising wages rates in covered industries, and lowering them in uncovered industries

19 Lieberman & Hall; Introduction to Economics, 2005 19 Using The Theory: The Minimum Wage Only one group of workers in which everyone benefits: skilled workers  Should come as no surprise that for many decades the most vocal advocates of raising the minimum wage have been labor unions Membership is disproportionately made up of skilled workers What do economists think about the minimum wage?  Most regard it as an inefficient policy for helping poor working families

20 Lieberman & Hall; Introduction to Economics, 2005 20 Using The Theory: The Minimum Wage You might think that economists would overwhelmingly oppose any increase in minimum wage  But that is not the case Those who favored an increase in minimum wage tended to believe the effect on unemployment was much smaller than those who opposed an increase Others may believe that higher unemployment is more likely to influence policy in a direction they favor The minimum wage, like most issues of public policy, is not as simple as it appears


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