chapter 19 v2

Some Determinants of Equilibrium Wages

• Jobs are different and wages are different

• Compensating Differentials

o This term means a difference in wages that arises to offset the

nonmonetary characteristics of different jobs

o Nonmonetary characteristics: safety, difficulty, fun, etc.

o The better the job as given by those characteristics, the higher the supply

of labor

• Thus, “good” jobs will tend to have lower equilibrium wages

than “bad” jobs

• To get people to take the “bad” jobs, firms will need to raise

the wage

• Meanwhile, those who take the “good” jobs will have benefits

that are not included in wages

o EX: night shift vs. day shift – night shift earns more as it’s not as desirable

to work at night and sleep during the day

o EX: those who mine coal are paid more than workers with similar skills

due to the compensation for dirty, dangerous conditions and potential

long-term health problems

• Human Capital

o Human capital represents the accumulation of investments in

people

o EX: on-the-job training, education

o Firms find more-educated workers more desirable (higher MPL), and

workers know they’re more marketable when they’re more educated

• Workers are willing to pay for more education only if there is a

reward

• Gains over uneducated workers are even more impressive in

undeveloped countries

• Difference in wages between highly and less educated workers can

be considered a compensating differential for the cost of becoming

educated

o The demand for skilled labor has increased more than the demand for

unskilled labor in recent years, increasing the earnings gap, leading to

greater inequality between the wages of skilled and unskilled workers

• More international trade, in which the US tends to export more

goods produced by skilled labor and import goods produced by

unskilled labor

• More technology, which replaces unskilled labor and requires

skilled labor to operate

• Ability, Effort, and Chance

o These things are difficult to measure, but they impact earnings

o Natural ability plays a big role in earnings

Summary 19 AP Economics – Cohen

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• EX: intelligence, strength, natural skill

o People who are hard workers (more effort) will also earn higher wages

o Chance can also affect wages

• EX: learning a trade before it becomes obsolete

o Beauty can also allow people to earn more money

• An Alternative View of Education: Signaling

o Firms may interpret education as a signal of ability to do work, even

if people don’t necessarily become more productive when they

receive the degree

o This idea is similar to advertising as a signal of quality

o Whether this argument or the human capital argument is the best, both

exhibit increased wages for the educated, and the true effects likely

include some combination of the two

• Human capital: education makes workers more productive

• Signaling: education corresponds to natural ability

• The Superstar Phenomenon

o Good teachers, plumbers, painters, etc, earn more than bad ones (we

hope), but they don’t earn astronomically more than bad ones

o Good actors, athletes, etc, earn much more than those who are not elite

o Economists’ point of view regarding the markets of these superstars:

• Every customer in the market wants to enjoy the good supplied by

the best producer

• Possible for everyone to enjoy their work simultaneously,

unlike a painter or plumber

• The good is produced with a technology that makes it possible for

the best producer to supply every customer at low cost

• EX: See them on TV, DVD, etc.

• Wages Above Equilibrium

o Wages usually balance labor supply and labor demand, but not always

o Minimum wages

• We have already discussed this concept...the wage is higher than it

would be without the fixing of the wage (for those with jobs with

wages low enough to be affected by the minimum wage)

o Unions – associations of workers that bargain with employers over wages

and working conditions

• Unions can threaten to go on strike – withhold labor – to put

pressure on firms to raise wages

o Efficiency wages – higher than equilibrium wages paid by firms in hopes

of increasing productivity of workers

• These wages often reduce worker turnover, increase worker

effort, and raise the quality of workers who apply for jobs at the

firm

o Wages above equilibrium will increase the supply of labor but

decrease the demand for labor, resulting in a surplus of labor

(unemployment)

Summary 19 AP Economics – Cohen

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The Economics of Discrimination

• Discrimination represents the offering of different opportunities to similar

individuals who differ only by race, ethnic group, sex, age, or other personal

characteristics

• Measuring Labor Market Discrimination

o We can’t just look at differences and think the numbers prove a

significant difference

• EX: White men are 75% more likely than Black men to have a

college degree

• EX: public schools in predominantly White areas tend to have

better schools than in predominantly Black areas

• Compensating differentials may also play a role

• EX: secretaries vs. truck drivers – wages depend highly on

working conditions, but each job is skewed toward one

gender

o While there may be discrimination, it’s difficult to measure considering

everything else to take into account

• Discrimination by Employers

o Are employers responsible when wages are lower than they should be?

o Motivation for profits should dissuade employers from hiring

anyone but the best for the job

• EX: blondes vs. brunettes – if only brunettes are hired, a slick firm

would hire able blondes and pay less, earning more profits...over

time, demand for blondes would increase until the wage

differential disappears

o Business owners are usually more interested in profit than

discrimination, and even if discrimination is present, it may be from

an external source

• EX: the local government forced southern railroads to be

segregated

• Discrimination by Customers and Governments

o If a firm is discriminating, but customers’ preferences are aligned with

the firm’s discrimination, then the natural market forces will not act to

eliminate the wage differential

• In this situation, the customers who have no preference would pay

a lower price while those who discriminate would pay a higher

price

o If a government enacts laws supporting discrimination, the practices will

not be eliminated

• EX: segregation on trains (see above)

o If a firm is truly profit-maximizing, it tends not to discriminate

o Wage differentials persist in competitive markets only when

customers are willing to pay to support the discriminatory practices

or when the government mandates it

Summary 19 AP Economics – Cohen

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• Statistical Discrimination

o This type of discrimination arises because an irrelevant but observable

personal attribute is associated with a relevant but unobservable

characteristic

o Note: the word “association” should be used – not correlation – even if it’s

in your textbook

o If employers use data to help them decide whom to hire, their choices

could be discriminatory

• In practice, it could be as simple as not hiring anyone who admits

having a past criminal record, even if that record may not prevent

that person from doing a good job

• It could also mean not hiring someone of a particular race or

background because of some statistic about that person’s profile

that is unfairly held against them