1. Labor Markets and Wage Rates
Chapter 28
Labor Markets and Wage Rates
28-1
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Objectives The supply of labor The demand for labor
High wage rates and economic rent
Real wages and productivity
The minimum wage
The living wage
28-2
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

3. Income Disparity
Why do some individuals make millions and millions of dollars a year while the typical American wage earner was paid between $25,000 and $35,000
There are several reasons but the bottom line is supply and demand
28-3
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

4. The Supply of Labor Noncompeting groups
There are three classes of labor
Skilled, semiskilled, unskilled
In a sense there are thousands of noncompeting groups
However, if there are opportunities in certain fields, people will go through the necessary training and compete for the jobs
So in another sense, we are all competitors in the same employment pool
In the long run most of can learn to do many different jobs
In the short run we are all partial substitutes for one another
28-4
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

5. The Theory of the Dual Labor Market
The theory of the dual labor market places the labor force into two broad categories
The primary market and the secondary market
The primary market has most of the good jobs, which not only pay well but offer good opportunities
The secondary market market consist of all the jobs that are left over
So-called disposable workers fill these low-pay, dead end, and often temporary jobs
28-5
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

6. The Theory of the Dual Labor Market
The theory of the dual labor market is a class theory of employment
The rich stay rich and the poor stay poor
The college degree seems to be the dividing line
However, you also need to be educated – the two are not necessarily synonymous
The theory of the dual labor market does not account for the huge middle level of occupations but it does support the contention that there are noncompeting groups in the labor market
28-6
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

7. The Backward-Bending Labor Supply Curve
The substitution effect
As the wage rate rises, people are willing to substitute more work for leisure because leisure time is becoming more expensive
The income effect
At some point, as your wage rate continues to rise, you are willing to give up some income in exchange for more leisure time
After all, you need more leisure time to spend all the money you are now making
28-7
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

8. Hypothetical Labor Supply Curve
A person will be willing to work an increasing amount of hours per week as the hourly wage rate goes up. But at some point (point J in this instance) he or she will begin to cut back on the hours worked as the wage rate continues to rise.
Up to point J, work is substituted for leisure time (substitution effect)
Beyond point J the curve bends backward as the income effect outweighs the substitution effect and the person is willing to trade away some money for more leisure time
28-8
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

9. The Demand for Labor
Demand is the firm’s Marginal Revenue Product schedule (MRP)
The MRP schedule slopes down and to the right
When the price of a good is lowered, more of it is demanded; when it is raised, less is demanded
The demand for labor is a derived demand
It is derived from the demand for the final product that the labor produces
28-9
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

10. Hypothetical General Demand Curve for Labor
This is the sum of every firm’s MRP curve. As the wage rate is lowered, increasing quantities of labor are demanded
28-10
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

11. Labor and Productivity
Obviously, workers who are more productive will generally be in more demand and better paid than less productive workers
Some people are more productive because of
Education and training
Work experience
Greater natural abilities
28-11
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

12. Labor and Productivity
Relatively high productivity cannot be completely explained by education
In many instances, people of widely varying productivity earn the same wage regardless of education or ability
Productivity only partially explains wage differentials
Specialized skills possessed by some workers influence demand for labor
Some workers are in demand because of natural abilities they possess
28-12
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

13. Nonhomogeneous Jobs
Pay differentials adjust for harder, more unpleasant, less convenient work
Just how does society get its dirty work done?
By paying people enough to make it worth their while
By calling on oppressed minorities to work at very low pay because they cannot get any other work
28-13
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

14. Hypothetical General Demand and Supply for Labor
The wage rate is set by the intersection of the general demand and supply curves for labor. In this case the wage rate is about $16 an hour
How much would the actual wage rate be? A lot lower? In many cases, yes. It all depends on the type of work you do and on the demand and supply schedules in each of hundreds, or even thousands of job markets
28-14
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

15. High Wage Rates and Economic Rents
Determination of Economic Rent by Supply and Demand
How much of David Letterman’s earnings are economic rent? If his earnings of $30 million are set by supply and demand, then his economic rent would depend on the minimum wage he would be willing to accept. If that were $5 million, then his economic rent would be $25 million
When ever a person gets paid more than the minimum she would be willing to accept, we call the excess economic rent.
28-15
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

16. Real Wages and Productivity
By real wages, economists mean what you can actually buy with your wages
Inflation erodes your purchasing power
A person earning $10,000 in 1970 would need about $40,000 today to maintain the same lifestyle
Why can’t we just give everyone pay increases that more than keep pace with inflation?
Prices would just rise as fast or faster than your wage increases and your increasing dollars would buy less and less
The key question is, “What can you buy with your money?” not, “How much money are you making?”
28-16
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

17. Real Wages versus Nominal Wages
The national standard of living can’t rise unless national production rises
For real wages to grow, output per labor-hour must grow
Between 1947 and 1978 output per labor-hour rose 104 percent
During this period real wages rose 105 percent
Since 1978 output per labor-hour has risen only 1 percent a year
Real wages have not not increased at all
Real wages and output per labor-hour have a parallel relationship
28-17
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

18. Indexes of hourly compensation cost in U. S
Indexes of hourly compensation cost in U.S. dollars for production workers in manufacturing, U.S. and selected countries, 2001
28-18
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19. Real Wages versus Nominal Wages
Problem: Your wage rate rises from $5 an hour in 1993 to $8.40 an hour in Meanwhile the consumer price index (CPI) rises from 100 in 1993 (the base year) to 120 in 1999 (the current year). How much is your real hourly wage in 1999, and by what percentage has it increased since 1993
29-19
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

20. Real Wages Versus Nominal Wages
Problem: Your wage rate rises from $5 an hour in 1993 to $8.40 an hour in Meanwhile the consumer price index (CPI) rises from 100 in 1993 (the base year) to 120 in 1999 (the current year). How much is your real hourly wage in 1999, and by what percentage has it increased since 1993
Money wages (current year)
Real wage (current year) = X 100
CPI (current year)
29-20
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

21. Real Wages Versus Nominal Wages
Problem: Your wage rate rises from $5 an hour in 1993 to $8.40 an hour in Meanwhile the consumer price index (CPI) rises from 100 in 1993 (the base year) to 120 in 1999 (the current year). How much is your real hourly wage in 1999, and by what percentage has it increased since 1993
Money wages (current year)
Real wage (current year) = X 100
CPI (current year)
$8.40
= X 100
120
29-21
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

22. Real Wages Versus Nominal Wages
Problem: Your wage rate rises from $5 an hour in 1993 to $8.40 an hour in Meanwhile the consumer price index (CPI) rises from 100 in 1993 (the base year) to 120 in 1999 (the current year). How much is your real hourly wage in 1999, and by what percentage has it increased since 1993
Money wages (current year)
Real wage (current year) = X 100
CPI (current year)
$8.40
= X 100
120
= $.07 X 100 = $7.00
29-22
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

23. Real Wages versus Nominal Wages
Problem: Your wage rate rises from $5 an hour in 1993 to $8.40 an hour in Meanwhile the consumer price index (CPI) rises from 100 in 1993 (the base year) to 120 in 1999 (the current year). How much is your real hourly wage in 1999, and by what percentage has it increased since 1993
Money wages (current year)
Real wage (current year) = X 100
CPI (current year)
$8.40
= X 100
120
= $.07 X 100 = $7.00
Change
Percentage change =
Original number
29-23
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

24. Real Wages versus Nominal Wages
Problem: Your wage rate rises from $5 an hour in 1993 to $8.40 an hour in Meanwhile the consumer price index (CPI) rises from 100 in 1993 (the base year) to 120 in 1999 (the current year). How much is your real hourly wage in 1999, and by what percentage has it increased since 1993
Money wages (current year)
Real wage (current year) = X 100
CPI (current year)
$8.40
= X 100
120
= $.07 X 100 = $7.00
Change $2
Percentage change = =
Original number $5
29-24
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

25. Real Wages versus Nominal Wages
Problem: Your wage rate rises from $5 an hour in 1993 to $8.40 an hour in Meanwhile the consumer price index (CPI) rises from 100 in 1993 (the base year) to 120 in 1999 (the current year). How much is your real hourly wage in 1999, and by what percentage has it increased since 1993
Money wages (current year)
Real wage (current year) = X 100
CPI (current year)
$8.40
= X 100
120
= $.07 X 100 = $7.00
Change $2
Percentage change = =
= .04 = 40% increase
Original number $5
28-25
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

26. Real Wages versus Nominal Wages
Problem: Ms. Klopman has been working at the same job since 1989, the base year. She was making $400 a week at that time, and now, in 1999, she is earning $540 a week. If the CPI rose to 180 to 1999 , how much are Ms. Klopman’s real wages in 1999 and by what percentage did they change?
28-26
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

27. Real Wages versus Nominal Wages
Problem: Ms. Klopman has been working at the same job since 1989, the base year. She was making $400 a week at that time, and now, in 1999, she is earning $540 a week. If the CPI rose to 180 to 1999, how much are Ms. Klopman’s real wages in 1999 and by what percentage did they change?
Money wages (current year)
Real wage (current year) = X 100
CPI (current year)
$540
= X 100
180
= $3 X 100 = $300
Change
$100
Percentage change = =
= .25 = 25% decrease
Original number
$400
28-27
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

28. The real wage now is below the level in the late 1970s
Index of Real Wages, (Base: Second Quarter of 1989 = 100) Bureau of Labor Statistics
The real wage now is below the level in the late 1970s
28-28
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

29. The Minimum Hourly Wage Rate
The Fair Labor Standards Act of 1938
Called for a 25 cent an hour minimum wage
This was raised to 30 cents in 1939
Called for a standard workweek of 44 hours
Reduced to 40 hours in 1940
Called for the payment of time and a half for overtime
Twenty-five cents in 1938 would buy approximately $3 worth of goods and services today
Minimum wage
1990 it was raised from $3.35 to $4.25
1996 it was raised to $4.75
1997 it was raised to $5.15
28-29
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

30. The Minimum Wage and the Unemployment Rate
Monthly Unemployment Rate, 1996, 1997, and / January February March April May June July August September October November December
Green indicates minimum wage increase in that particular month and year
28-30
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

31. Should There Be a Minimum Wage Rate?
Conservatives say the minimum wage law hurts the very people it is supposed to help
They claim the basic effect of the minimum wage is to cause millions of marginal workers to be unemployed
They point to rising teenage unemployment as proof
28-31
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

32. Should There Be a Minimum Wage Rate?
Who earns the minimum wage rate?
In 2003 nearly 3 million Americans did
Two-thirds were adults
Most of the rest were teenage members of low-income families for whom the wages were an important source of income
28-32
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

33. Should There Be a Minimum Wage Rate?
Who in America can live on $5.15 an hour?
Who in America is worth less than $5.15 an hour?
28-33
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34. The Living Wage
The living wage is a minimum hourly wage that must be paid to employees of major contractors doing business with over 100 municipalities
Only about 150,000 workers are covered nationwide
In most cases the stipulated hourly rate is between $7.50 and $10.00 and hour
28-34
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

35. Last Word
Labor unions have raised wages of their members by restricting the supply of labor
The minimum wage and the living wage laws have placed a floor under wages
These are two instances of interference with the functioning of the market forces of supply and demand
At best, about 20 percent of our labor force is affected by unions, the minimum wage, or the living wage
The bottom line remains that the wage rate is determined by supply and demand
28-35
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.