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Chapter 8
The Wage Structure

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

3. Homogenous Workers and Jobs
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Homogenous Workers and Jobs
Assume that the wage of $10 in submarket a is higher than the wage in other submarkets.
Quantity of Labor Hours
Wage rate
S0a
D0a Q0
$10
S1a Q1 $8
Assuming that jobs and workers are homogenous and information and mobility is costless, workers will leave the other submarkets for higher paying submarket a.
This will decrease the labor supply in the other submarkets and increase the labor supply in submarket a (S0 to S1).
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).

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

5. Hourly Earnings By Occupational Group, 2006
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Hourly Earnings By Occupational Group, 2006
Occupational Group
Hourly Wage
Management, Business, And Financial
$29.09
Installation, Maintenance, And Repair
18.68
Sales Workers
17.12
Office and Administrative Support
14.83
Service Workers
11.84
Farming, Fishing, And Forestry
9.85

6. Hourly Earnings By Industry Group, 2006
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Hourly Earnings By Industry Group, 2006
Industry Group
Hourly Wage
Mining
$24.13
Finance, Insurance, Real Estate
24.06
Public Administration
23.44
Transportation, Warehousing, Information, and Utilities
21.60
Manufacturing
20.67
Construction
18.29
Services
18.10
Retail Trade
13.56

7. Private Manufacturing Worker’s Hourly Earnings By State, 2006
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Private Manufacturing Worker’s Hourly Earnings By State, 2006
State
Hourly Wage
Connecticut
$26.54
New Jersey
25.77
Massachusetts
25.04
New York
20.65
Pennsylvania
20.62
Ohio
19.20
Florida
18.15
Arkansas
16.42
Mississippi
14.65

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

9. Compensating Differentials
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Compensating Differentials
Compensating 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. Compensating Differentials
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Compensating Differentials
Sources 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

11. Compensating Differentials
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Compensating Differentials
Job location
Cities with greater amenities pay lower wages.
Cities with greater cost of living pay higher nominal wages.
Job security
Jobs with greater job security pay lower wages.
Prospect of wage advancement
Jobs with greater wage advancement have lower starting wages.

12. Compensating Differentials
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Compensating Differentials
Extent of control over the work place
Jobs with less personal control over the workplace and less flexible work hours pay higher wages.

13. Differing Skill Requirements
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Differing Skill Requirements
Jobs 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.
Skill differentials can increase, decrease, or reverse wage differences caused by compensating differentials.
Example: Nurses earn more than ditch diggers

14. Efficiency Wage Payments
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Efficiency Wage Payments
Shirking 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.
Turnover model
Firms will pay above-market wages when hiring and training costs are high.
Empirical evidence
There is mixed empirical evidence.

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

16. Other Job or Employer Heterogeneities
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Other Job or Employer Heterogeneities
Firm 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.

17. 4. Wage Differentials: Heterogenous Workers
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4. Wage Differentials: Heterogenous Workers

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NonCompeting Groups
Individuals 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.

19. Differing Preferences
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Differing Preferences
Differences in time preferences
Persons who are presented-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.

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

21. 6/5/2018
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.

22. 5. The Hedonic Theory of Wages
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5. The Hedonic Theory of Wages

23. Indifference Map Wage Rate
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Indifference Map
Nonwage amenity (job safety)
Wage Rate I1 I2 I3
The “hedonic” indifference map is composed of a number of indifference curves.
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.

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Isoprofit Curve
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.
Nonwage amenity (job safety)
Wage Rate P
The isoprofit curve gets steeper with higher levels of job safety since it gets more and more expensive to increase job safety.
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.
Firms differ in their ability to increase job safety and thus have different isoprofit curves.

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Matching
The slope of isoprofit curve PA is less steep than curve PB,which implies the marginal cost of job safety is more expensive at firm B than at firm A. IB IA PA
Nonwage amenity (job safety)
Wage Rate PB B SB WB
Indifference curve IA is steeper than curve IB which implies that person A is more risk averse than person B.
Workers maximize utility by being tangent to the highest possible isoprofit curve. A SA WA
The risk averse worker will work for the firm able to raise safety at low marginal cost. The worker will get wage WA and safety SA.
The risk loving worker will work for the firm able to raise safety at high marginal cost. The worker will get wage WB and safety SB.

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

27. Labor Market Implications
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Labor Market Implications
Workers 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.

28. 6. Wage Differentials: Labor Market Imperfections
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6. Wage Differentials: Labor Market Imperfections

29. Wage Rate Distributions
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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.
In this example, 20 percent of workers will earn between $6.80 and $6.99 per hour. However, 5% of the workers will earn between $6.00 and $6.19, while another 5% will earn between $7.60 and $7.79.
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.

30. Lengthy Adjustment Period
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Lengthy Adjustment Period
An increase in labor demand initially may cause a substantial wage increase to W0 in occupations with lengthy training periods.
Units of Time
Wage Rate W0
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 W1. W2 W3 We W1
For a time the wage rate may oscillate above and below the long-run equilibrium wage rate We before equilibrium in the market is finally restored.
During the transition periods, wage differentials between this occupation and others paying We will be observed.

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Immobilities
Labor immobilities are impediments to the movement of labor and can cause wage differentials.
Geographic immobilties
Costs to moving can deter migration and thus permit wage differentials to exist across geographic areas.
Institutional immobilties
Restrictions on mobility imposed by the government or unions can deter mobility.
Occupational licensing, apprenticeships

32. Immobilities Sociological immobilties
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Immobilities
Sociological immobilties
Race and gender discrimination will cause racial and gender wage differentials to exist.

33. 6/5/2018
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.

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End Chapter 8