Labor markets and income distribution

Today: Value of work, human capital, unions,

discrimination, and income distribution

Today: 5 mini-lectures about labor markets Value of work

How much is labor worth? Human capital

Training, education, experience, etc. Unions

Direct effects and indirect effects Discrimination

What does theory tell us about discrimination?

Income distribution Is income inequality a bad thing?

Value of work

Will every person get the same wage for the same hour of work?

Maybe It depends what the structure of the

market is It depends on the marginal value of

the hour of work

Suppose a competitive labor market

If each person’s hour of work results in $50 in additional output, should each worker get paid $50 per hour? Not quite You have to deduct the firm’s costs

Capital costs Input costs Transaction and handling costs

Simple example with input and capital costs

I need $20 in supplies and one hour to build a small cabinet

The firm I work for also needs to rent a cubicle, at $8 per hour

Once I finish building the cabinet, the firm can sell it to a wholesaler for $50

What is my worth to the company?

What is my worth to the company? The company is willing to pay up to $22

per hour for my labor to build cabinets Costs: $28 (supplies and cubicle) Benefits: $50

In a competitive environment, if Firm X offers less then $22, Firm Y can offer me more than what Firm X does

The battling between Firms X and Y will continue until one offers $22

Marginal product of labor In this example, my marginal product

(MP) of an hour of labor is 1 cabinet The value of my marginal product

(VMP) of an hour of labor is the additional value my hour of work produces: $22

All workers just like me will earn $22 per hour in a competitive labor market

Suppose that you could build two cabinets per hour

Should you earn $22 per hour? No

Costs per hour: $48 (Supplies for two cabinets and one hour’s cubicle rental)

Benefits per hour: $100 (two cabinets) You should earn $52 per hour for your

work

Back to an old example# of

empl./dayPhones per

day

0 0

1 20

2 45

3 55

4 63

5 67

Recall the following information

Phones sell for $18 each Variable cost is $100 per worker Only other costs are fixed

Different analysis, same resultProduce as long as VMP > $100

# of empl./day Phones per day

MP (extra phones per day)

VMP ($ per day)

0 0

20 360

1 20

25 450

2 45

10 180

3 55

8 144

4 63

4 72

5 67

Hire?

Yes

Yes

Yes

Yes

No

Recall this table from Lecture 6: We hire 4 workers either way

# of empl./day

Phones per day

MB ($/phone) MC ($/phone)

0 0

18.00 5.00

1 20

18.00 4.00

2 45

18.00 10.00

3 55

18.00 12.50

4 63

18.00 25.00

5 67

When analyzing labor problems…

You can often choose the method you use to maximize a firm’s benefits

Notice that we get the same answer either way

Summary: Value of work In a competitive labor market, the long-

run equilibrium wage is a worker’s VMP More productive workers will get paid more

in a competitive environment equilibrium Some labor problems that were analyzed

using the MB/MC approach can also be analyzed using a VMP approach

Human capital

Human capital comprises of the characteristics that affect the value of the person’s work when hired

The better the characteristics of human capital, the more a person is likely to earn

Some human capital qualities Education

Direct knowledge Intelligence Signaling

Training Work and life

experiences

Energy level Work habits Trustworthiness Initiative

Education sends many messages to a potential employer

“I have learned everything needed to finish this level of education”

“I am intelligent enough to finish this education, which probably means I am smarter than those without my level of education”

“I am using this level of education to send a signal that I have other good qualities that you are looking for; others that do not finish this level of education can say the same thing”

Education and employment

Many jobs require a minimum level of education to be considered for a job M.D. to be hired as a doctor License for many specialized fields

Real estate Pilot

High school or college diploma for many entry-level jobs

Education and employment

The more education you have, the higher you are in demand for your services Exceptions: People that get a Ph.D. in

the humanities often end up in the same type of job that they had before

For more on education

See “Mandatory starting dates for kindergarten,” p. 367

See Economic Naturalist 13.4, p. 387

A new class is being developed in the Economics department

Summary: Human capital

Many characteristics form human capital Education probably most important

for most people Human capital is valued by

employers due to the fact that it increases a workers productivity

Unions

Unions form so that workers can collectively bargain Wages Working conditions

Unions and wages

Can anyone unionize and demand higher wages? In most cases, yes Demands will not always be agreed to As wage increases, the firm can

employ fewer people profitably

When are unions effective?

Finding qualified workers outside of a union is difficult or impossible Example: Writers’ strike

See “Additional reading” on class website for more on this topic

When a firm is making economic profits

When a unionized firms can hire better workers than nonunionized firms

Quote from writers’ strike article

“In the world of labor negotiations today, the writer of a hot TV show has more power than an auto assembly worker with a rivet gun.”(From “Writers a rarity — a union with power.” Posted 11/5/07. See http://www.msnbc.msn.com/id/21598412/)

Why can writers form a powerful union?

Few good outsourcing options Requires specialized skills Unionization of all writers means that

no writer will write for a show without the union’s “blessing” “Scabs” that write without the union’s

blessing during a strike are often unable to obtain work once the strike is over

What can networks do to combat the writers’ union?

More unscripted programming Reality shows Game shows Sports TV news magazines (60 Minutes,

20/20, etc.) “Specials” (Barbara Walters,

concerts)

Summary: Unions Unions can be effective in some

situations When workers doing the same kind of

job are heterogeneous in human capital

When replacement workers cannot easily be found

No good outsourcing options Nobody outside of the union is able to do

the job

Discrimination

The “wage gap” between men and women has been a hot topic for decades

How much of this is due to discrimination?

How much of this is due to other factors?

Recall human capital theory

Human capital theory says that wages are determined by factors such as education and experience

Education likely to affect wage gap Mid-20th century: More men than

women with college education Today: 4 women graduate college for

every 3 men

The wage gap, declining

As more women enter the work force, the wage gap declines More women enter a job with the

same education as men Despite changes in education,

there is still a wage gap

What else explains the wage gap?

Holding constant important factors such as occupation, education, field of expertise, and years of experience Men often choose majors with high

salary potential after graduation Math, science

What else explains the wage gap?

Customer discrimination Examples

Lawyers Physicians

Incorrect conclusions about the relative productivity of men and women

Does discrimination actually occur?

Probably Likely due to the incorrect

conclusions about the productivity of men and women

Does discrimination actually occur? Example of what might be

occurring Some managers may look at two

candidates for a promotion, one male, one female

Both are nearly equally qualified On paper, most managers would

promote the woman 90% of managers would promote the

woman based solely on human capital

Does discrimination actually occur? Some managers may have experiences

from the past that “women are family oriented” and “men are career oriented”

Although today’s workforce is more homogeneous than it used to be, some managers may subconsciously favor the man when the gender of both applicants is known When gender of both is known, maybe only

30% of managers promote the woman

Does discrimination actually occur?

In jobs where men are mostly managers, they may incorrectly weigh human capital traits High weight to human capital traits

that men have more of Low weight to human capital traits

that women have more of

Does discrimination actually occur? What will happen when these managers

“get it wrong?” Promotion of a lower-productivity worker Lower productivity leads to lower profits Lower profits lead to a higher likelihood that

a business in a perfectly competitive environment will not survive in the long-run

Higher productivity worker may find a better job at another firm

Does discrimination actually occur? Results of this example

When human capital differences are clear, the best candidate will get the promotion

When human capital differences are not clear, the promotion may be more likely to go the male worker

Perfectly competitive firms that discriminate are less likely to survive in the long run

Summary: Discrimination A wage gap between men and women’s

pay has existed for decades Some of this can be explained by

controlling for education, experience, and other factors

Some discrimination may be occurring Firms that do discriminate based on factors

such as gender and race are less likely to be competitive in the long run

Income distribution

Is income inequality a bad thing? Some argue that people would prefer

more income equality Others argue that economic

incentives are needed to keep the “economic pie” from getting smaller

Mean income table (families), from F/B, p. 411 (2000 dollars)

Real income growth, 1980-2000 Bottom 20% has been flat Top 20% has seen huge growth (59%)

Quintile 1980 1990 2000Bottom 20 percent

$12,756 $12,625 $14,232

Second 20 percent

$27,769 $29,448 $32,268

Middle 20 percent

$41,950 $45,352 $50,925

Fourth 20 percent $58,200 $65,222 $74,918

Top 20 percent $97,991 $121,212 $155,527

Top 5 percent $139,302 $190,187 $272,349

The gap between rich and poor widens

The rich are getting richer, but the poor are notnot getting poorer

The middle class has seen moderate real growth in income 16-29% growth for the categories in

the middle 60%

The “veil of ignorance”

John Rawls, a moral philosopher, came up with the following argument to create income equality “Veil of ignorance”

Conceals knowledge and talents from people

Risk averse people will want to have income equality under these conditions

No inferiority, jealousy or envy based on income

Problems with income inequality

Those that are relatively poor may feel inferior This problem may perpetuate to their

children Jealousy towards other people Envy towards other people’s

accomplishments

Problem: The “economic pie” will shrink with Rawls’ ideas

If income was guaranteed to be equal to everyone, nobody will have an economic incentive to gain human capital Smaller “economic pie”

Less human capital People work less

Is there an optimal amount of income inequality?

Impossible to answer Different people have different

opinions about effectiveness of realistic ways to redistribute income

Some methods of income redistribution (& their problems)

Welfare payments Little economic incentive to get off of

welfare without time limits Negative income tax

Incentive to work for pay diminishes

Some methods of income redistribution (& their problems)

Minimum wage Unemployment

Public employment of the unemployed Needs to have enough incentives for

unemployed people to want to work Needs to have incentives low enough for

employed people to stay in their old job

A success story ofincome redistribution

The earned-income tax credit (EITC) The “working poor” receive a sizable

credit for working and making an income in a given range

Essentially a negative income tax for those working and making low incomes

Summary: Income distribution In recent decades, income inequality

has grown Due mostly to large real growth in upper

income groups Income equality is a moral issue, but

with many costs when implemented The EITC is a success story of balancing

income redistribution and economic incentives