Chapter 13: Wage Determination

• Wages are price that employers pay for labor

• Wage rate - Price paid per unit of labor services

• Nominal wage - Amount of money received per hour/day/year

• Real wage - Quantity of goods and services a worker can obtain with nominal wages; real wages reveal the “purchasing power” of nominal wages

  • Depends on nominal wage + prices of goods/services purchased

• Role of productivity

  • Greater productivity → Greater demand
  • Plentiful capital
  • Access to abundant natural resources
  • Advanced technology
  • Labor quality
  • Other factors like management, sizes of markets, etc.

• Real wages + productivity

  • Real income per worker increases at same rate as output per worker
  • Increases in labor demand > Increases in labor supply
  • Long-run increase in wage rates + employment

• Purely-competitive labor market - Numerous firms competing; qualified workers w/ identical skills; “wage takers”

  • Supply curve slopes upward
  • Firms pay higher wages → Attract workers away from alternative job opportunities
  • Intersection of the market labor demand curve and the market labor supply curve determines the equilibrium wage rate and level of employment
  • Maximize profits by hiring up until MRP = MRC
  • MRC = Resource price
  • Only earning normal profit

  

(The green area is the firm’s total wage cost; the brown area is its nonlabor costs, including a normal profit)

• Monopsony - A market in which a single employer of labor has substantial buying (hiring) power

  • Only single buyer of labor
  • “Wage maker”
  • Labor supply curve for market + firm are identical
  • Upward sloping supply curve
  • Paying a uniform wage to all workers means that the cost of an extra worker—the marginal resource (labor) cost (MRC)—is the sum of that worker’s wage rate and the amount necessary to bring the wage rate of all current workers up to the new wage level
  • MRC above supply curve
  • Hires smaller # of workers + pays less than competitive wage rate
  • Examples
  • Small # of hospitals in a city → Lower starting wages
  • Professional sports leagues

  

• Unions

  • Demand-enhancement model
  • Increase demand for goods/services produced → Increase demand for labor
  • Political lobbying
  • Altering price of inputs
  • Supporting policies that reduce prices of complementary resources
  • Exclusive/craft union model
  • Reduce supply of labor
  • Restrict # of workers that can join union
  • Exclusive unionism - By excluding workers from unions and therefore from the labor supply, craft unions succeed in elevating wage rates
  • Occupational licensing - A group of workers in a given occupation pressure Federal, state, or municipal government to pass a law that says that some occupational group (for example, barbers, physicians, lawyers, plumbers, cosmetologists, egg graders, pest controllers) can practice their trade only if they meet certain requirements
  • Inclusive/industrial union model
  • Inclusive unionism - Organizing all available workers, no matter skill level
  • Increase in supply of labor → No drop in wages b/c workers organizing w/ union

• Bilateral monopoly - Combo of monopsony + inclusive unionism

  • The monopsonistic employer will seek the below-competitive-equilibrium wage rate, and the union will press for some above competitive-equilibrium wage rate
  • Monopolies can cancel out

• Minimum wage controversy

  • Case against
  • Cause employers to hire fewer workers
  • “Poorly targeted” to reduce household poverty
  • Case for
  • Could cause employers to hire more workers
  • Could help firms raise productivity

• Wage differentials - Hourly wage rates and annual salaries differ greatly among occupations

  • Caused by differences in supply + demand
  • Strength of labor demand differs among occupations
  • Non-competing groups - Each representing different occupations for which members of a group qualify
  • Ability/physical attributes
  • Education + training
    • Human capital - The personal stock of knowledge, know-how, and skills that enables a person to be productive and thus to earn income

• Compensating differences - Wage differentials paid to compensate for nonmonetary differences in various jobs

  • Help allocate society’s scarce labor resources

• Market imperfections that impede workers from moving from lower-paying jobs to higher-paying jobs

  • Lack of job information - Workers may simply be unaware of job opportunities and wage rates in other geographic areas and in other jobs for which they qualify
  • Geographic immobility - Many workers are reluctant to move to new places
  • Unions + gov’t restraints - Wage differentials may be reinforced by artificial restrictions on mobility imposed by unions and government
  • Discrimination - Results in lower wages being paid to women and minority workers than to white males doing very similar or even identical work

• Pay for performance

  • Workers are the firms’ agents; they are hired to advance the interest (profit) of the firms. The principals are the firms; they hire agents to advance their goals.
  • Interests of firms + workers not identical → Principal agent problem arises
  • Incentive pay plan - Ties worker compensation more closely to worker output or performance
  • Piece rates - Compensated based on # of units produced
  • Commissions/royalties
  • Bonuses, stock options, profit sharing
  • Efficiency wages
  • Problems
  • Poor product quality
  • Fraudulent sales practices
  • Free-riding
  • Manipulating costs + revenue streams