1. Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 8 The Wage Structure

2. 8-2 1. Perfect Competition: Homogenous Workers and Jobs

3. 8-3 Homogenous Workers and Jobs Assume that the wage of $10 in submarket a is higher than the wage in other submarkets. Assuming that jobs and workers are homogenous and information and mobility is costless, workers will leave the other submarkets for higher paying submarket a. The equilibrium wage rate will decrease in submarket a and rise in the other submarkets until the wage rate is the same in all submarkets ($8). Quantity of Labor Hours Wage rate S 0a D 0a Q0Q0 $10 S 1a Q1Q1 $8 This will decrease the labor supply in the other submarkets and increase the labor supply in submarket a (S 0 to S 1 ).

4. 8-4 2. The Wage Structure: Observed Differential

5. 8-5 Hourly Earnings By Occupational Group, 2008 Occupational GroupHourly Wage Management, Business, And Financial $31.50 Installation, Maintenance, And Repair $19.76 Sales Workers $17.58 Office and Administrative Support $15.78 Service Workers $12.74 Farming, Fishing, And Forestry $11.29

6. 8-6 Hourly Earnings By Industry Group, 2008 Industry GroupHourly Wage Finance, insurance, real estate$25.55 Mining$25.32 Public administration$25.27 Transportation, warehousing, information, and utilities$22.88 Manufacturing$22.60 Construction$20.23 Services$19.63 Retail trade$14.50

7. 8-7 Private Manufacturing Worker’s Hourly Earnings By State, 2008 StateHourly Wage New Jersey$29.69 California$27.16 Texas$22.79 New York$22.42 Florida$20.71 Iowa$19.13 Alabama$18.23 Arkansas$15.77 Mississippi$14.95

8. 8-8 3. Wage Differentials: Heterogenous Jobs

9. 8-9 Compensating Differentials oCompensating wage differentials consist of extra pay that an employer must provide a worker for some undesirable job characteristic that does not exist in alternative employment. The wage differential is caused by a decreased labor supply for the job that has the undesirable job characteristic and an increased labor supply for the alternative employment.

10. 8-10 Compensating Differentials oSources of compensating differentials Risk of job injury or death ∞Riskier jobs pay higher wages. Fringe benefits ∞Jobs with greater fringe benefits pay lower wages. Job status ∞Jobs with greater prestige pay lower wages. Job location ∞Cities with greater amenities pay lower wages. ∞Cities with greater cost of living pay higher nominal wages.

11. 8-11 Compensating Differentials Job security ∞Jobs with greater job security pay lower wages. Prospect of wage advancement ∞Jobs with greater wage advancement have lower starting wages. Extent of control over the work place ∞Jobs with less personal control over the workplace and less flexible work hours pay higher wages.

12. 8-12 Differing Skill Requirements oJobs that require more education and training will pay a higher wage rate than those that do not. The wage difference between skilled and unskilled workers is called the skill differential. oSkill differentials can increase, decrease, or reverse wage differences caused by compensating differentials. Example: Nurses earn more than ditch diggers.

13. 8-13 Efficiency Wage Payments oShirking model Firms will pay above-market wages where it is costly to monitor employee performance or the employer’s cost of poor performance is high. oTurnover model Firms will pay above-market wages when hiring and training costs are high. oEmpirical evidence is mixed.

14. 8-14 Other Job or Employer Heterogeneities oUnion status Union workers earn more than nonunion workers. ∞Most of the differential is an economic rent to union workers. oDiscrimination Discrimination against women and minorities exists in some markets and creates wage differentials.

15. 8-15 Other Job or Employer Heterogeneities oFirm size Large firms pay higher wages than small firms. ∞Large firms are more likely to be unionized. ∞Workers at large firms may be more productive. ~Training, better workers, greater capital ∞Higher wages may be a compensating wage differential.

16. 8-16 4. Wage Differentials: Heterogenous Workers

17. 8-17 NonCompeting Groups oIndividuals differ in the type, amount, and quality of their human capital. The result is the labor force consists of noncompeting groups of workers that are not easily substitutable for each other. In the short run, these differences in human capital generate wage differentials. In the long run, the wage differentials cause individuals to move to higher paying jobs to some extent.

18. 8-18 Differing Preferences oDifferences in time preferences Persons who are present-oriented (i.e., have a high discount rate) are not willing to sacrifice present consumption without a large increase in future income. Persons who are future-oriented (i.e., have a high discount rate) are willing to sacrifice present consumption for a small increase in future income. Persons with lower discount rates acquire more human capital and thus create wage differentials.

19. 8-19 Differing Preferences oDifferences in tastes for nonwage aspects of jobs People have different preferences for job security, location, and risk. These differences in preferences create wage differentials.

20. 8-20 Questions for Thought 1. Discuss: “Many of the lowest-paid people in the society—for example, short-order cooks– also have relatively poor working conditions. Hence, the theory of compensating wage differentials is disproved.” 2. Explain why “pay comparability” legislation requiring that the public sector remunerate government employees at wages equal to private- sector counterparts might create excess supplies of labor in public-sector labor markets.

21. 8-21 5. The Hedonic Theory of Wages

22. 8-22 Indifference Map The “hedonic” indifference map is composed of a number of indifference curves. Nonwage amenity (job safety) Wage Rate I1I1 I2I2 I3I3 Each individual curve shows the various combinations of wage rates and a particular nonwage amenity (for example job safety) that yield a specific level of total utility. Each curve to the northeast reflects a higher level of total utility. A steep curve implies that the person is risk averse—it takes a large increase in the wage rate to compensate for a small reduction in job safety.

23. 8-23 Isoprofit Curve Nonwage amenity (job safety) Wage Rate P The employer’s isoprofit curve shows the various combinations of wage rates and a particular nonwage amenity (for example job safety) that yield a given level of total profit. Competition among firms will result in only normal profits (zero economic profit) in the long run. Firms will have to make their wage rate-job amenity decisions along a curve such as P. The isoprofit curve gets steeper with higher levels of job safety since it gets more and more expensive to increase job safety. Firms differ in their ability to increase job safety and thus have different isoprofit curves.

24. 8-24 Matching The slope of isoprofit curve P A is less steep than curve P B, which implies the marginal cost of job safety is more expensive at firm B than at firm A. Workers maximize utility by being tangent to the highest possible isoprofit curve. The risk averse worker will work for the firm able to raise safety at low marginal cost. The worker will get wage W A and safety S A. Indifference curve I A is steeper than curve I B which implies that person A is more risk averse than person B. The risk loving worker will work for the firm able to raise safety at high marginal cost. The worker will get wage W B and safety S B. A SASA WAWA IBIB IAIA PAPA Nonwage amenity (job safety) Wage Rate PBPB B SBSB WBWB

25. 8-25 Labor Market Implications oWorkers with fewer nonwage amenities will get higher wages. oLaws with minimum safety standards may reduce utility of some workers. Risk loving workers would prefer higher wages to greater safety. oPart of the male-female wage differential may reflect differences in preferences for nonwage amenities. Women may prefer shorter commuting distances and safer jobs.

26. 8-26 Labor Market Implications oWorkers with strong preferences for fringe benefits will match up with firms that can provide fringe benefits at low cost. Cafeteria plans which allow workers to choose from a variety of fringe benefits allow workers to get higher utility since they are not forced to accept a fixed bundle.

27. 8-27 6. Wage Differentials: Labor Market Imperfections

28. 8-28 Wage Rate Distributions If information and job search is costly, then a single equilibrium wage for a specific occupation is not likely to occur. A range of possible wages will exist for an occupation. These wage differentials will not cause job switching since the expected marginal benefits of the higher wage are exceeded by the expected marginal cost of obtaining the information. In this example, 20 percent of workers will earn between $8.80 and $8.99 per hour. However, 5% of the workers will earn between $8.00 and $8.19, while another 5% will earn between $9.60 and $9.79.

29. 8-29 Lengthy Adjustment Period An increase in labor demand initially may cause a substantial wage increase to W 0 in occupations with lengthy training periods. For a time the wage rate may oscillate above and below the long-run equilibrium wage rate W e before equilibrium in the market is finally restored. But the supply response to higher wage may create surplus of labor to the occupation in the next period, driving the wage rate lower to W 1. During the transition periods, wage differentials between this occupation and others paying W e will be observed. Units of Time Wage Rate W0W0 W1W1 W2W2 W3W3 WeWe WeWe

30. 8-30 Immobilities oLabor immobilities are impediments to the movement of labor and can cause wage differentials. oGeographic immobilties Costs to moving can deter migration and thus permit wage differentials to exist across geographic areas.

31. 8-31 Immobilities oInstitutional immobilties Restrictions on mobility imposed by the government or unions can deter mobility. ∞Occupational licensing, apprenticeships oSociological immobilties Race and gender discrimination will cause racial and gender wage differentials to exist.

32. 8-32 Question for Thought 1. Suppose that (a) employees must pay higher wages to attract workers from wider geographic areas and hence higher wages are associated with longer commuting distances (less of the amenity “closeness of job to home”) and (b) females have greater tastes for having jobs close to their homes than males. Use the hedonic wage model to show graphically why a male-female wage differential might emerge, independently of skill differences or gender discrimination.