1. MBMC Labor Markets, Poverty, and Income Distribution Labor Markets, Poverty, and Income Distribution

2. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 2 Introduction Observations People with similar skills earn very different incomes. Some of the world’s wealthiest people come from poor countries. Many Americans are homeless and malnourished.

3. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 3 The Economic Value of Work The Market for Labor Equilibrium wage and quantity are determined by the supply of and demand for a specific category of labor. Changes in supply and demand will change the equilibrium wage and quantity.

4. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 4 The Economic Value of Work Observation Wages will differ among workers with different levels of productive ability. Example How much will potters earn?

5. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 5 The Economic Value of Work Mackintosh Pottery Works: Is in a competitive market. Price of pots = $1.10/each. Clay is available at no cost and is the only input. Rennie and Laura are the only potters. Cost = $0.10 handling fee/pot. Rennie produces 100 pots/wk and Laura produces 120 pots/wk.

6. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 6 The Economic Value of Work Marginal Product of Labor (MP) The additional output a firm gets by employing one additional unit of labor Value of Marginal Product of Labor (VMP) The dollar value of the additional output a firm gets by employing one additional unit of labor

7. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 7 The Economic Value of Work Assuming a competitive labor market: Rennie’s wage will be $100. Laura’s wage will be $120. The wage equals the value of marginal product (VMP).

8. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 8 The Economic Value of Work Value of Marginal Product Marginal product of labor multiplied times the net price of each unit sold  Rennie’s VMP = (100 pots)($1.10 -.10) = $100  Laura’s VMP = ($120 pots)($1.10 -.10) = $120 In a competitive market:  Wage = VMP

9. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 9 Employment and Productivity in a Woodworking Company (when cutting boards sell for $20 each) Number of workers Total number of cutting boards/week VMP ($/week) MP (extra cutting boards/week)0 130 255 376 494 5108 30600 25500 21420 18360 14280 Competitive labor market Wage = $350/wk MP reflects diminish returns If VMP > wage - continue to hire Adirondack would hire 4 workers At a given wage the number employed depends on: MP of the worker Price of the product

10. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 10 The Occupational Demand for Labor Employment in firm 1 (person-hours/day) Wage ($/hour) Employment in firm 2 (person-hours/day) Wage ($/hour) D 1 = VMP 1 D 2 = VMP 2 6 12 100150 6 12 50100 + +

11. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 11 The Occupational Demand for Labor Total Employment (person-hours/day) Wage ($/hour) D = VMP 1 + VMP 2 250150 6 12 = =

12. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 12 The Supply Curve of Labor Employment of programmers (person-hours/year) Wage ($/hour) S L2L2 L1L1 W1W1 W2W2 Supply for a specific occupation is upward- sloping. Supply for the economy may be vertical or downward- sloping.

13. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 13 The Effect of an Increase in the Demand for Computer Programmers Employment of programmers (person-hours/year) Wage ($/hour) S L1L1 W1W1 D1D1 L2L2 W2W2 D2D2 Changes in equilibrium W & Q occur when the supply and/or demand for labor changes.

14. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 14 Explaining Differences in Earnings When labor markets are competitive, differences in wages are determined by differences in VMPs.

15. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 15 Explaining Differences in VMPs Human Capital  An amalgam of factors such as education, training, experience, intelligence, energy, work habits, trustworthiness, and initiative that affect the value of a worker’s marginal product. Explaining Differences in Earnings

16. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 16 Explaining Differences in VMPs Human Capital Theory  A theory of pay determination that says a worker’s wage will be proportional to his or her stock of human capital Explaining Differences in Earnings

17. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 17 Explaining Differences in VMPs Labor Union  A group of workers who bargain collectively with employers for better wages and working conditions Explaining Differences in Earnings

18. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 18 Explaining Differences in VMPs Changes in demand can influence the value of human capital. Explaining Differences in Earnings

19. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 19 An Economy with Two Nonunionized Labor Markets Employment in market 1 Wage ($/hour) Employment in market 2 Wage ($/hour) 125 9 75 9 D 1 = VMP 1 D 2 = VMP 2

20. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 20 An Economy with Two Nonunionized Labor Markets Total employment (workers/day) Wage ($/hour) S0S0 200 9 D = VMP 1 + VMP 2 A nonunionized labor market W = $9 & Q = 200

21. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 21 The Effect of a Union Wage Above the Equilibrium Wage Employment in market 1 (unionized market) Wage ($/hour) D 1 = VMP 1 125 W U = 12 Employment in market 2 (nonunionized market) Wage ($/hour) 75100 D 2 = VMP 2 9 W N = 6 9 100 Market 1 unionizes and sets W = $12 Employment falls to 100 Mkt 2 W falls to $6 and employment increases to 100 Loss in economic surplus

22. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 22 Economic Naturalist If unionized firms have to pay more, how do they manage to survive in the face of competition from their nonunionized counterparts? Explaining Differences in Earnings

23. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 23 Economic Naturalist Unionization may increase productivity by:  Allowing employers to set higher employment standards.  Improving communication.  Improving morale.  Reducing turnover. Explaining Differences in Earnings

24. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 24 Economic Naturalist The impact of unions on wage differentials is probably small because:  The union wage premium is small.  Only 1 in 6 workers belong to a union. Explaining Differences in Earnings

25. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 25 Compensating Wage Differentials The wage rate depends on the VMP and the working conditions. Explaining Differences in Earnings

26. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 26 Economic Naturalist Why do some ad copy writers earn more than others? Explaining Differences in Earnings

27. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 27 Economic Naturalist Which job would you choose?  Writing ad copy for the American Cancer Society or Camel cigarettes oThey both pay the same, $30,000/yr oBoth have the same prospects for advancement How much would you have to be paid to switch? Explaining Differences in Earnings

28. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 28 Economic Naturalist Cornell Survey  90% chose the American Cancer Society  Median wage premium = $15,000 Explaining Differences in Earnings

29. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 29 Compensating Wage Differential The differences in the wage rate -- positive or negative -- that reflects the attractiveness of a job’s working conditions Examples  Job safety oPolice and fire-fighters  Schedules oDay vs. night oTeachers Explaining Differences in Earnings

30. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 30 Discrimination in the Labor Market Competitive labor theory predicts that wage differentials not based on differences in VMP will be eliminated. However, women and minorities continue to receive lower wages than white males with similar measures of human capital. Explaining Differences in Earnings

31. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 31 Employer Discrimination An arbitrary preference by an employer for one group of workers over another Explaining Differences in Earnings

32. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 32 Discrimination by Employers Assume  Male and female employees are equally productive.  An employer prefers to hire male employees.  Male employees are paid more. Explaining Differences in Earnings

33. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 33 Discrimination by Employers Then:  The discriminating firm’s profit will be less.  Firm’s employing females will be more profitable.  The demand for females will increase and female wage rates will rise until it equals the wage for males and the VMP.  To discriminate, the employers would pay males a wage that is greater than their VMP and reduce their profit. Explaining Differences in Earnings

34. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 34 Discrimination by Others Customer Discrimination  The willingness of consumers to pay more for a product produced by members of a favored group, even if the quality of the product is unaffected  Socialization within the family Explaining Differences in Earnings

35. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 35 Other Sources of the Wage Gap Willingness to accept risk Quality versus quantity of education Courses taken and degrees pursued by sex and race Explaining Differences in Earnings

36. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 36 Winner-Take-All Markets One in which small differences in human capital translate into large differences in pay Explaining Differences in Earnings

37. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 37 Economic Naturalist Why does Renee Fleming earn millions more than sopranos of only slightly lesser ability? Explaining Differences in Earnings

38. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 38 Mean Income Received by Families in Each Income Quintile and by the Top 5 Percent of Families, 1980-2000 (2000 dollars) Quintile 1980 20001990 Bottom 20 percent$ 12,756$ 12,625$ 14,232 Second 20 percent27,76929,44832,268 Middle 20 percent41,95045,35250,925 Fourth 20 percent58,20065,22274,918 Top 20 percent97,991121,212155,527 Top 5 percent139,302190,187272,349

39. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 39 Recent Trends in Inequality Observations From WWII to the 1970s income growth was almost 3%/yr for all groups. From 1980-2000 the income growth of the bottom 20% was less than half of 1%. Real income of the top 1% more then doubled from 1980 - 2000.

40. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 40 Recent Trends in Inequality Observations In 1980, CEOs earned 42 times as much as the average worker; today they earn 500 times as much. The U.S. has a high degree of upward and downward economic mobility.

41. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 41 Is Income Inequality a Moral Problem? Choosing the Rules for Distributing Income Assume  A “veil of ignorance”  National income is fixed  Most people are risk adverse

42. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 42 Is Income Inequality a Moral Problem? What Do You Think? How would people choose to allocate the income?

43. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 43 Is Income Inequality a Moral Problem? What Do You Think? What would happen to the incentive to work if wealth depended on productivity and everyone was guaranteed an equal amount of income?

44. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 44 Is Income Inequality a Moral Problem? Rewards for hard work and risk taking raise national income. Such rewards lead to inequality.

45. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 45 Is Income Inequality a Moral Problem? The inequality created by a market system may be inefficient if people would choose less inequality when choosing distributional rules from behind a “veil of ignorance.”

46. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 46 Methods of Income Redistribution Difficulties in Developing Programs to Reduce Income Inequality Identifying who will receive benefits Undermining the incentive to work

47. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 47 Methods of Income Redistribution Welfare Payments and In-kind Transfers Assistance to the poor includes:  Cash transfers  In-kind transfers

48. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 48 Methods of Income Redistribution In-Kind Transfer A payment made not in the form of cash, but in the form of a good or service

49. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 49 Methods of Income Redistribution Welfare Payments and In-kind Transfers Aid to Families with Dependent Children (AFDC)  Federal Cash Transfer Program  Criticisms oCreated an incentive for the father to leave the household oReduced the incentive to work

50. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 50 Methods of Income Redistribution Welfare Payments and In-kind Transfers 1996 Personal Responsibility Act  Responsibility of welfare transferred to the states  States receive a lump-sum payment from the federal government  Five-year lifetime limit on receipt of benefits  Debatable on how successful the program has been

51. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 51 Methods of Income Redistribution Means-Tested Benefit Programs Benefit level declines as the recipient earns additional income May make people better off if they do not work Costly to administer

52. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 52 Methods of Income Redistribution The Negative Income Tax (NIT) Every person would receive a tax credit. A person with no income would receive the credit in cash. People who earn income would receive the tax credit and pay taxes on their income at less than 100%.

53. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 53 Methods of Income Redistribution The Negative Income Tax (NIT) Advantages  Incentive to work  Lower administrative cost

54. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 54 Methods of Income Redistribution The Negative Income Tax (NIT) An Example  Poverty threshold in 2001 = $18,000 for a family of four living in a city  Assume the NIT credit = $18,000  Eight families pool their payments ($144,000) and move to a rural location and produce their own food

55. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 55 Methods of Income Redistribution The Negative Income Tax (NIT) An Example  Creates and incentive not to work  The political cost is high because the NIT guarantees income to all who do not work

56. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 56 W L0L0 L1L1 W min Unemployment The Effect of Minimum Wage Legislation on Employment Employment Wage ($/hour) S D

57. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 57 Employer surplus without minimum wage Worker surplus without minimum wage Worker and Employer Surplus in an Unregulated Labor Market L (person-hours/day) W ($/hour) By how much will a minimum wage reduce total economic surplus? S D 5,000 5 10 10,000 0

58. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 58 The Effect of a Minimum Wage on Economic Surplus S W ($/hour) D 5,000 5 10 10,0003,000 3 7 L (person-hours/day) 0 Employer surplus with minimum wage Worker surplus with minimum wage Reduction in total surplus caused by minimum wage

59. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 59 Methods of Income Redistribution The Earned-Income Tax Credit (EITC) A policy under which low-income workers receive credits on their federal income tax In 2004, family of four with earned income of $13,000 had an EITC of $4,000.

60. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 60 Methods of Income Redistribution Example Using an Earned-Income Tax Credit  With no minimum wage, employment = 5,000 person-hours/day  Workers get paid $5/hr  Worker surplus is $4,000/day less than with the minimum wage  The tax credit would be $0.80/hr for 5,000 person hours/day

61. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 61 Methods of Income Redistribution Example If the EITC were financed by a $4,000 tax on employers, employer surplus would be $4,000 greater than under the $7 minimum wage.

62. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 62 Methods of Income Redistribution Public Employment for the Poor Overcomes the shortcomings of the EITC and NIT  EITC does not help the unemployed  NIT reduces the incentive to work

63. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 63 Methods of Income Redistribution Public Employment for the Poor Disadvantages of public service employment  People may leave private sector jobs.  The output created by the jobs may not have any value.  Increase in government bureaucracy.

64. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 64 Methods of Income Redistribution A Combination of Methods Use a NIT with payment set below the poverty threshold Set the public service wage below the minimum wage Privatize the management of the public service employment program

65. MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14: Labor Markets, Poverty, and Income Distribution Slide 65 NIT Public Job NIT + Public Job NIT + Private Job Income by Source in a Combination NIT – Jobs Program Poverty threshold

66. MBMC End of Chapter End of Chapter