1. The Labor Market Economics, Sixth Edition Boyes/Melvin Chapter 30

2. 2 Copyright © Houghton Mifflin Company. All rights reserved. Individual Labor Supply Households supply labor. People in the households allocate their time to work or to leisure. – This leads to individuals having to make a labor supply decision based upon the labor-leisure tradeoff. The backward-bending labor supply curve results because a person is willing and able to work more hours as the wage rate increases until, at some sufficiently high wage, the person chooses to work fewer hours. – The person feels that he or she has enough income, and would rather have more leisure time. – At a high enough wage rate, the person feels that he or she can afford to take more leisure time.

3. 3 Copyright © Houghton Mifflin Company. All rights reserved. The Individual’s Labor Supply Curve

4. 4 Copyright © Houghton Mifflin Company. All rights reserved. Labor Market Supply The decision about whether or not to offer your labor services is a decision about labor force participation. The backward bend and other features of the individual supply curves depends upon individual preferences. When the individual supply curves are aggregated, the variations average out, and the labor market supply curve is upward sloping.

5. 5 Copyright © Houghton Mifflin Company. All rights reserved. The Labor Market Supply Curve

6. 6 Copyright © Houghton Mifflin Company. All rights reserved. Labor Market Equilibrium Note: This model assumes that all workers and all jobs are the same.

7. 7 Copyright © Houghton Mifflin Company. All rights reserved. Wage Differentials If all workers were identical, if all jobs were identical, and if all information were perfect, there would be no wage differentials—all workers would earn the same wage. The reasons for wage differences include compensating wage differentials and differences in individual productivity.

8. 8 Copyright © Houghton Mifflin Company. All rights reserved. Compensating Wage Differentials Compensating wage differentials: wage differences that make up for the higher risk or poorer working conditions of one job over another. Some jobs are more dangerous or more unpleasant. Workers demand higher wages to be willing to supply their labor to these jobs. The supply curve of labor for these jobs lies above the supply curve of labor for less desirable jobs. This results in a higher equilibrium wage and an equilibrium differential—the compensation the worker demands and gets for undertaking the riskier, less desirable job.

9. 9 Copyright © Houghton Mifflin Company. All rights reserved. Compensating Wage Differentials

10. 10 Copyright © Houghton Mifflin Company. All rights reserved. Human Capital People differ with respect to their skills. These difference influence the level of wages for two reasons: – Skilled workers have higher marginal productivity than unskilled workers, and – The supply of skilled workers is smaller than the supply of unskilled workers. As a result, skilled workers will receive higher wages than unskilled workers. The expectation of higher wages will induce people to acquire human capital—skills and training acquired through education and job experience.

11. 11 Copyright © Houghton Mifflin Company. All rights reserved. Human Capital

12. 12 Copyright © Houghton Mifflin Company. All rights reserved. Investment in Human Capital Just as firms invest in physical capital, we say that individuals invest in human capital. – These individuals are purchasing education and training in order to achieve higher output and income in the future. As with all other economic decisions, the decision to invest in human capital is made in terms of whether the expected benefits will exceed the costs.

13. 13 Copyright © Houghton Mifflin Company. All rights reserved. Income Profiles and Educational Level

14. 14 Copyright © Houghton Mifflin Company. All rights reserved. Discrimination Discrimination is a form of prejudice that occurs when factors unrelated to marginal revenue product affect the wages or jobs that are obtained. It is another reason for wage differentials. Discrimination is costly in that less productive employees or more expensive but not more productive employees are used by the firm. It is contrary to profit maximization. Discrimination may be personally based or statistical. – Personal discrimination is based upon prejudices on the part of employers, fellow workers, or customers. – Statistical discrimination results when an indicator of group performance is incorrectly applied to an individual member of that group.

15. 15 Copyright © Houghton Mifflin Company. All rights reserved. Occupational Segregation Statistical discrimination and imperfect information can lead to crowding—forcing a group into certain kinds of occupations. At one time, women were pushed into secretarial, clerical or support roles. The separation of jobs by sex is called occupational segregation.

16. 16 Copyright © Houghton Mifflin Company. All rights reserved. Discrimination

17. 17 Copyright © Houghton Mifflin Company. All rights reserved. CEO Pay Packages CEOs earn more than 200 times as much as the average worker. In 2002, the median salary of CEOs in companies listed in the S&P 500 stock index was $7 million. How could anyone justify such large salaries for CEOs and differences between the pay of top CEOs and the average worker?

18. 18 Copyright © Houghton Mifflin Company. All rights reserved. Explaining CEO Salaries (1) One answer is that the market failed. – The owners of firms exert little day-to-control over CEOs and the CEO’s pay. – CEOs take advantage of this and award themselves large salaries. – But CEO salaries are set by the boards of directors, not by the CEOs themselves. Another answer is that the board members conspire to pay high wages because the CEO may sit on the boards of directors of the firms that set their salaries.

19. 19 Copyright © Houghton Mifflin Company. All rights reserved. Explaining CEO Salaries (2) A third explanation has to do with the nature of the compensation package that CEOs receive. – In 1999 salary accounted for just 9.73% of the compensation of CEOs. – Stock options accounted for 58.52%. – The idea is that if the CEO manages the firm correctly, the stock price will rise, and the CEO will enjoy a large salary. Thus the CEO’s incentives are consistent with the interests of the shareholders of the company. – In 2001 and 2002, the stock market broadly declined, which was blamed on general economic conditions. To retain CEOs in the face of this, firms began to raise their base salaries.

20. 20 Copyright © Houghton Mifflin Company. All rights reserved. Explaining CEO Salaries (3) When the CEO is generating enormous incomes for shareholders, the shareholders are very willing to pay the CEO handsomely. In essence, the marginal revenue product of the CEO warrants the high pay. It is harder to understand when CEOs are paid high salaries while their companies lose money. In some cases it is argued that the losses would have been higher had the company had a less-talented CEO. The high CEO salaries may serve as incentives to those who have not yet achieved CEO status, making them more productive. Another explanation is the superstar effect: people with small differences in abilities or productivity receive vastly different levels of compensation.

21. 21 Copyright © Houghton Mifflin Company. All rights reserved. Wage Differentials and Government Policies Since the 1930s, about 30 states enacted for employment practice laws prohibiting discrimination in employment on the basis of race, color, creed, or national origin. (Sex discrimination was not covered.) With the Civil Rights Act of 1964 it became unlawful for any employer to discriminate on the basis of race, color, religion, sex, or national origin. Exceptions are only permitted in cases where religion, sex, or national origin is a bona fide occupational qualification for the job.

22. 22 Copyright © Houghton Mifflin Company. All rights reserved. Tests of Discrimination Disparate treatment: treating individuals differently because of their race, sex, color, religion, or national origin. Disparate impact: it is the result of different treatment, not the motivation, that matters.

23. 23 Copyright © Houghton Mifflin Company. All rights reserved. Comparable Worth The persistent wage gap between men and women has led to another approach— “equal pay for equal work”. More formally, this is called comparable worth—the pay ought to be determined by the job characteristics rather than by supply and demand, and jobs with comparable requirements should receive comparable wages. Proponents of this approach argue that market-determined wages are not appropriate because of the market’s inability to assess marginal products. Opponents argue that interference with the function of the labor market will lead to shortages in some occupations and excess supplies in others.

24. 24 Copyright © Houghton Mifflin Company. All rights reserved. Comparable Worth