Chapter 29 Labor Markets and Wage Rates 29-1 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Objectives The supply of labor The demand for labor High wage rates and economic rent Real wages and productivity The minimum wage dispute 29-2 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

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 29-3 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

The Supply of Labor Noncompeting groups –There are three classes of labor Skilled, semiskilled, and 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 us can learn to do many different jobs In the short run we are all partial substitutes for one another 29-4 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

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 29-5 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

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 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 29-6 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

The 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 29-7 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Labor Supply Curve 29-8 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. A person will be willing to work an increasing amount of hours per week as the hourly wage rate goes up. But a 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

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 29-9 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical General Demand Curve for Labor Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. This is the sum of every firm’s MRP curve. As the wage rate is lowered, increasing quantities of labor are demanded

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 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

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 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

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 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical General Demand and Supply for Labor Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. 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

High Wage Rates and Economic Rents Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. 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.

Real Wages and Productivity By real wages, economist mean what you can actually buy –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?” Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Real Wages and Productivity 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% During this period real wages rose 105% –Since 1978 output per labor-hour has risen only 1% a year Real wages have not not increased at all –Real wages and output per labor-hour have a parallel relationship Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Hourly Wages and Fringe Benefits in Manufacturing, Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Real Wages versus Nominal Wages Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. 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

Real Wages versus Nominal Wages Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. 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 Real wage (current year) = X 100 Money wages (current year) CPI (current year)

Real Wages versus Nominal Wages Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. 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 Real wage (current year) = X 100 Money wages (current year) CPI (current year) = X 100 $

Real Wages Versus Nominal Wages Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. 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 Real wage (current year) = X 100 Money wages (current year) CPI (current year) = X 100 $ = $.07 X 100 = $7.00

Real Wages versus Nominal Wages Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. 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 Real wage (current year) = X 100 Money wages (current year) CPI (current year) = X 100 $ = $.07 X 100 = $7.00 Percentage change = Change Original number

Real Wages versus Nominal Wages Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. 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 Real wage (current year) = X 100 Money wages (current year) CPI (current year) = X 100 $ = $.07 X 100 = $7.00 Percentage change = Change Original number $2 $5 =

Real Wages versus Nominal Wages Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. 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 Real wage (current year) = X 100 Money wages (current year) CPI (current year) = X 100 $ = $.07 X 100 = $7.00 Percentage change = Change Original number $2 $5 ==.04 = 40% increase

Real Wages versus Nominal Wages Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. 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?

Real Wages versus Nominal Wages Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. 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? Real wage (current year) = X 100 Money wages (current year) CPI (current year) = X 100 $ = $3 X 100 = $300 Percentage change = Change Original number $100 $400 ==.25 = 25% decrease

Index of Real Wages, (Base: Second Quarter of 1989 = 100) Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. The real wage now is below the level in the late 1970s

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 In 1990 it was raised from $3.35 to $4.25 In 1996 it was raised to $4.75 In 1997 it was raised to $ Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

The Minimum Wage and the Unemployment Rate Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Monthly Unemployment Rate, 1996, 1997, and 1998 / January February March April May June July August September October November December Green indicates minimum wage increase in that particular month and year

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 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Demand and Supply Schedule for Unskilled Labor Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. The equilibrium wage rate is $3.75 The minimum wage is $4.25 There is a surplus of about 4 million workers How many of these 4 million marginal workers would work for $3.75?

Elastic Demand and Supply Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. The elimination of a minimum wage rate of $4.25 allows the wage rate to fall to its equilibrium level of $3.45, resulting in a jump in employment from 7 million to more than 18 million

Elastic Demand and Inelastic Supply of Labor Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. The elimination of a minimum wage rate allows employment to rise from 7.3 million to just over 19 million

29-35 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Eliminating the minimum wage raises employment only 0.4 million Inelastic demand and elastic supply Inelastic demand and supply

A Summing Up Will employment of unskilled and inexperienced workers rise if we eliminate the minimum wage? –Yes. But the question is by how much –It will rise very little if the demand for labor is very elastic There is no question that teenagers, particular nonwhite teenagers are the last hired and the most poorly paid –Is this because they are relatively unskilled and inexperienced? –Is this because they are discriminated against? –Are older workers really more productive? –Would teenagers work for lower than minimum wage? Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Wages Are Set Institutionally Wages are set institutionally with little regard to marginal analysis Because wages are set institutionally, it makes little sense to abolish the minimum wage law On the other hand there is some truth to the contention that some teenagers are priced out of the labor market by the minimum wage. The question is, How many? There is also one eternal truth that cannot be ignored –The price of labor, like the price of just about everything else, is affected by the law of supply and demand Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.