PPA 723: Managerial Economics Lecture 16: Input Markets The Maxwell School, Syracuse University Professor John Yinger

Managerial Economics, Lecture 16: Input Markets Outline  The Basic Analytics of an Input Market  The Labor Market and Income Inequality  Discrimination in Labor Markets

Managerial Economics, Lecture 16: Input Markets The Labor Market  Supply: The labor-leisure trade-off.  Demand: Firms select the profit- maximizing number of workers to hire at each wage.  Called derived demand because it is derived from the firm’s interest in producing and selling a product.

Managerial Economics, Lecture 16: Input Markets The Demand for Labor  To maximize profits, the firm keeps hiring more workers until the marginal benefit from another worker equals the marginal cost.  Marginal benefit = amount of the product another worker can produce (MP L ) multiplied by the price of the product, P.  Marginal cost = wage rate = w.  So (MP L ) (P) = MRP L ( = VMP L ) = w.

Managerial Economics, Lecture 16: Input Markets Hiring by a Public or Non-Profit Manager  The decision rule that firms use, namely, hire until MRP L, = w, provides the intuition for public and non-profit hiring:  Hire until the value of another workers contribution to the goals of the agency equals the cost of hiring him or her.  But the rule is of little formal use, since the goals of the agency usually cannot be stated in dollars.

Managerial Economics, Lecture 16: Input Markets Table 15.1 Marginal Product of Labor, Marginal Revenue Product of Labor, and Marginal Cost

Managerial Economics, Lecture 16: Input Markets Figure 15.1a Labor Market Equilibrium Labor supply curve MRP L, Labor demand curve L, Workers per hour (a) Labor Profit-Maximizing Condition 6 w = w, VMP L, $ per unit

Managerial Economics, Lecture 16: Input Markets Figure 15.1b Output Market Equilibrium MC p q, Units of output per hour (b) Output Profit-Maximizing Condition MC, p, $ per unit

Managerial Economics, Lecture 16: Input Markets Labor Markets & the Distribution of Income  Labor earnings are the main source of income.  So the nature of the labor market has an enormous impact on the distribution of income.  No theorem says that competition leads to a distribution that is fair.

Managerial Economics, Lecture 16: Input Markets Evidence on Inequality  Peter Gottschalk and Sheldon Danziger, “Inequality of Wage Rates, Earnings and Family Income in The United States, 1975–2002,” Review of Income and Wealth, Series 51, Number 2, June 2005, pp  “While there is still considerable uncertainty about the causes of these changes, there is broad consensus that wage rate inequality is considerably higher at the start of the 21st century than it was a quarter of a century earlier. In fact, increases in wage rate and annual earnings inequality occurred primarily in the early 1980s, and were not reversed by a prolonged economic recovery during the 1990s.”

Managerial Economics, Lecture 16: Input Markets Inequality in Wages and income

Managerial Economics, Lecture 16: Input Markets Education and Earnings  Workers are paid the value of their marginal product.  More productive workers are paid more.  Education is the best way to become more productive.  The returns to education are large and have been increasing over time, leading to more inequality.

Managerial Economics, Lecture 16: Input Markets The Growing Return to Education

Managerial Economics, Lecture 16: Input Markets Discrimination in Labor Markets  Economic tools shed light on (but cannot, of course, fully explain) discrimination.  Because discrimination touches on values that many people feel strongly about, clear thinking requires precise definitions and careful attention to the positive/normative distinction.

Managerial Economics, Lecture 16: Input Markets Definitions for Studying Discrimination, 1  Race – A social classification of people based on superficial, easily observed physical traits with meaning in a particular society.  All humans are descended from Africans and share most of their genetic make-up.  The distribution of traits varies widely within any racial group, however defined.  There is no evidence that any racial group, however defined, is intrinsically different on any substantive trait.  Ethnicity – A social classification of people based on cultural characteristics, such as customs, language, religion, and nationality, that have been given meaning in a particular society.  In the U.S., Hispanic is an ethnic designation, as is Jewish or Italian or Muslim or Arab.

Managerial Economics, Lecture 16: Input Markets Definitions for Studying Discrimination, 2  Racial or Ethnic Prejudice is a strong negative attitude toward or belief about the members of a particular racial or ethnic group.  Racial or Ethnic Discrimination is behavior that denies the members of a racial or ethnic group the rights or privileges to which they are entitled.  Discrimination cannot be defined without determining entitlements.  In the U.S., a firm can use any reasonable set of qualifications to determine whether to hire, fire, promote, or train someone  But this set of qualifications cannot include membership in a legally protected class (race, religion, ethnicity, sex).  Segregation is the physical separation of different racial or ethnic groups (in employment, housing, etc.)

Managerial Economics, Lecture 16: Input Markets Theories of Discrimination  Discrimination can have many different causes, including  Employer prejudice  Employee prejudice  Customer prejudice  Signaling (statistical discrimination)  Discrimination is illegal regardless of the incentives that lead people to engage in it.

Managerial Economics, Lecture 16: Input Markets Model 1: Employer Prejudice  If an employer is prejudiced against people from a protected class, he/she must be compensated to hire them.  Let d indicate the profits a prejudiced employer is willing to forgo to avoid hiring a black. Then the employer keeps hiring whites until but uses a different standard for hiring blacks, namely  For equally productive workers, it follows that  Since d is positive, prejudiced employers offer a higher wage to whites than to blacks. This is clear-cut wage discrimination.

Managerial Economics, Lecture 16: Input Markets Model 2: Employee Prejudice  Now suppose employers aren’t prejudiced, but white employees are; in this case, hiring blacks raises the wage that must be paid to attract white employees.  Assume that blacks do not care about the racial composition of the workforce. (Other cases are obviously possible.)  Now if  W w at 100% white < W B, the firm hires only whites  W w at 100% white = W B, the firm hires whites or blacks, but not both  W w at 100% white > W B, the firm hires only blacks  Hence this model predicts firms will practice hiring discrimination to enforce complete workforce segregation, by firm or by occupation within a firm.

Managerial Economics, Lecture 16: Input Markets Model 3: Customer Prejudice  Employers may discriminate in an attempt to satisfy the prejudices (expected or actual) of their customers.  For example, a management consulting firm that gives advice to male CEO’s who do not want women to tell them what to do might (illegally!) discriminate against female applicants.

Managerial Economics, Lecture 16: Input Markets Statistical Discrimination  Statistical discrimination can arise when some worker characteristics, such as dedication or ability to learn on the job, cannot be observed at the time of hiring.  Employers may assume that a person has the average value for these unobserved traits for her (or his) group.  If past discrimination has left her group with lower values of these traits, then the employer will discriminate against her.  This is illegal; an employer cannot make decisions about an individual based on average traits for that individual’s group.

Managerial Economics, Lecture 16: Input Markets Evidence on Discrimination, 1  Marianne Bertrand and Sendhil Mullainathan, “Are Emily and Greg More Employable than Lakisha and Jamal?” American Economic Review, October  This study sent fictitious resumes to help-wanted ads in Boston and Chicago newspapers. Each resume was assigned either a very African American sounding name or a very White sounding name.  “The results show significant discrimination against African- American names: White names receive 50 percent more callbacks for interviews. We also find that race affects the benefits of a better resume. For White names, a higher quality resume elicits 30 percent more callbacks whereas for African Americans, it elicits a far smaller increase.”

Managerial Economics, Lecture 16: Input Markets Evidence on Discrimination, 2  Claudia Golden and Cecilia Rouse, “Orchestrating Impartiality: The Impact of Blind Auditions on Female Musicians, American Economic Review, September  A “blind” audition procedure, in which people tried out for an orchestra behind a screen, increased the number of women hired by roughly 50 percent.