MODERN PRINCIPLES OF ECONOMICSThird Edition

Labor Markets

Chapter 18

Outline

The Demand for Labor and the Marginal Product of Labor

Supply of Labor Labor Market Issues How Bad Is Labor Market Discrimination,

or Can Lakisha Catch a Break?

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Introduction

This chapter examines the factors underlying the demand for labor and the supply of labor.

It explains: • How wages are determined. • Why Americans earn so much by global

standards. • Why education raises wages. • How much labor unions help workers.• How discrimination shapes labor markets.

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Definition

Marginal product of labor (MPL):

the increase in a firm’s revenues created by hiring an additional laborer.

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The Marginal Product of Labor

A firm is willing to hire a worker when the marginal product of labor is greater than the wage (cost). 5

The Marginal Product of Labor

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0 1 2 3 4 5 6 7 8 9 10

$40

30

20

10

Wage

Numberof janitors

Demand curve for labor

If market wage = $10, 7 janitors will be hired.

If market wage increases to $30, only 1 janitor will be hired.

Marginal product of labor

Demand for Labor

When the wage falls, firms hire more workers. Workers are assigned to less important tasks. As wage falls, so does the marginal product of

labor (MPL). Firms will keep hiring workers as long as the

MPL > wage.

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Supply of Labor

Market supply curve for labor is upward sloping. • Some, though not all, workers are likely to

work more as wages increase. • When wages in one industry increase, that

attracts workers from other industries. An individual supply curve could have a zero,

positive, or even negative slope.

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Individual Supply of Labor

9

//

7

Wage

Hours40 50

$28

20

16

Joe’s Supply of Labor

Joe works 40 hours when wage is between $7 and $16

Joe works more hours when wage is between $16 and $20

Joe works fewer hours when wage rises above $20

Individual Supply of Labor

10

Wage

Hours(millions)

7

$28

20

16

80 200 320 640

Market Supply of Labor

Market supply is upward sloping.

Labor Market

We can put together the supply and demand to represent the market for labor.

The price (wage) is found at the intersection of demand and supply.

A firm will keep hiring workers so long as MPL is greater than W.

For many firms and many workers, MPL = W.

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Labor Market

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Hoursper week(millions)

Wage

Supply

Demand(MPL)

$10

168

• There are 42 million janitors in the US, working 168 hours per week.

• The marginal product of a janitor is $10 per hour.

Market for Janitors

Labor Market Issues

U.S. versus Indian Wages

The productivity of U.S. firms raises the MPL of American workers. • More capital is invested per worker in the U.S. • American office workers, on average, are better

educated. • U.S. firms have better marketing, longer global

reach for their sales force, and greater investment in brand names.

• U.S. firms produce a more valuable product.

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Labor Market Issues

U.S. versus Indian Wages

Wage is determined not by skills alone but by the productivity of the entire economy.

A typical Indian worker would earn more in the U.S. than in India.

Supply of workers, and supply of low-skilled workers, are both higher in India.

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Janitors - U.S. versus India

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Wage

Hours per week(millions)

//

Demand, U.S.

Supply, U.S.

Supply, India

Demand, India

$10

QIndia.

$1

QU.S.

The productivity of U.S. firms raises the MPL and thus the wages of U.S. janitors.

Definition

Human capital:

tools of the mind; the stuff in people’s heads that makes them productive.

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Labor Market Issues

Human Capital

Wages within America differ greatly from worker to worker.

Some workers have higher wages than others because they have more human capital. • Human capital involves investment in education,

training, and experience. • On average, more education brings a higher wage. • Wages for a college graduate are almost double

those of a high school graduate.

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Labor Market Issues

Human Capital

Return to human capital is rising: • The ability to work with computers has made an

education more valuable. • Bottlenecks in grade-school education are limiting flows

into college. • Technology and competition from developing countries

have limited wage growth for low skilled jobs. • A degree signals intelligence, competence, and

conscientiousness.

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The Return to Education

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Definition

Compensating differential:

a difference in wages that offsets differences in working conditions.

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Labor Market Issues

Compensating Differentials

The real wage of a job includes not just the monetary pay but also the working conditions.

A dangerous job reduces the supply of labor, increasing the wage.

Being a musician is more fun but pays less than being an accountant.

Workers become less willing to accept risk as economic growth makes them wealthier.

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Compensating Differentials

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Number ofWorkers

Wage Supply, high risk

Demand

Supply, low risk

Nhigh risk

Whigh risk

Wlow risk

Nlow risk

Fewer workers at the same wage

Higher wage for same number of workers

Riskier jobs pay more, all else being equal.

Compensating Differentials

Wages adjust until similar jobs have similar compensation packages.

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More funless money

More moneyless fun

Labor Market Issues

Unions and Wages

The U.S. and Switzerland have lower unionization rates but wages similar to the rest of Western Europe.

Wages in unionized jobs tend to be higher than in nonunionized jobs.

Unions can improve labor / management relations and ensure employees are treated fairly.

Unions raise wages by reducing employment.

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Labor Market Issues

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Unions raise wages by restricting the supply of labor.

Wage

Number of workers

Demand

Supply with union

Supply without union

Nwith union

WW/O union

NW/O union

Wwith union

Labor Market Issues

Unions and Wages

Professionals such as doctors, lawyers, and accountants have professional associations that also restrict labor supply.

Unions can raise the wages of particular classes of workers.

Unions are not the fundamental reason why wages are high in the wealthy countries.

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Definition

Statistical discrimination:

using information about group averages to make conclusions about individuals.

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Labor Market Discrimination

Statistical discrimination

Discrimination is a useful shorthand for making some decisions.

However, it causes people to make many errors.

The long-run consequences can be very harmful to the penalized groups.

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TIMOTHY TADDER/CORBIS

Labor Market Discrimination

Preference-based discrimination

Three different kinds:

1. Discrimination by employers.

2. Discrimination by customers.

3. Discrimination by employees.

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Labor Market Discrimination

1. Discrimination by Employers

Bigoted employers discriminate based on race, ethnicity, religion, or gender.

The wages of people who are discriminated against will fall since demand for their labor falls.

This kind of discrimination tends to break down: • It is expensive to the employer. • It leads to bigots being outcompeted.

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Labor Market Discrimination

1. Discrimination by Employers

As employers compete for underpaid workers, wages will rise until they are close to marginal product for all workers.

As women move into higher paid sectors and delay having children, the wage gap between men and women decreases.

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Jackie Robinson faced great discrimination but he was a profitable hire for the Brooklyn Dodgers in 1947.

MLB PHOTOS/GETTY IMAGES

Labor Market Discrimination

2. Discrimination by Customers

Sometimes customer preferences encourage business owners to discriminate.

It is often subtle, as when country clubs, restaurants, and others try to encourage “the right kind of customers.”

The decline of employer-based discrimination weakens customer-based discrimination.

Discrimination is also weakened by economic growth.

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Labor Market Discrimination

3. Discrimination by Employees

Sometimes workers don’t want to mix with people from different groups.

Employers may find they have to pay other workers a higher wage.

It becomes cheaper to discriminate than to hire equally.

Discrimination of this kind can be self-reinforcing and difficult to identify.

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Labor Market Discrimination

Discrimination by Government

Government sometimes is the part of the problem rather than part of the solution.

Apartheid system of South Africa.

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Self-Check

Using information about group averages to make conclusions about individuals is called:

a. Preference-based discrimination.

b. Discrimination by employers.

c. Statistical discrimination.

Answer: c – this is called statistical discrimination.

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Takeaway

Wages are higher in wealthier countries because workers: • Work with more physical capital. • Have more education and training. • Work in a more efficient and flexible setting.

Compensating differentials explains why fun jobs pay less and dangerous jobs pay more.

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Takeaway

Unions can raise some workers’ wages, but are not a fundamental reason for high wages.

At least two kinds of discrimination occur in labor markets - statistical discrimination and preference-based discrimination.

Markets tend to break down discrimination over time.