labor markets, poverty, and income distribution

MB MC

Labor Markets, Poverty, and

Income Distribution

Labor Markets, Poverty, and

Income Distribution

Chapter 14: Labor Markets,Poverty, and Income Distribution

Slide 2

MB MC

Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.

Introduction

ObservationsPeople with similar skills earn very different

incomes.Some of the world’s wealthiest people

come from poor countries.Many Americans are homeless and

malnourished.


Slide 3

MB MC


The Economic Value of Work

The Market for LaborEquilibrium 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.


Slide 4

MB MC



ObservationWages will differ among workers with

different levels of productive ability.

ExampleHow much will potters earn?


Slide 5

MB MC



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.


Slide 6

MB MC



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


Slide 7

MB MC



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).


Slide 8

MB MC



Value of Marginal ProductMarginal product of labor multiplied times

the net price of each unit soldRennie’s VMP = (100 pots)($1.10 - .10) = $100Laura’s VMP = ($120 pots)($1.10 - .10) = $120

In a competitive market:Wage = VMP


Slide 9

MB MC


Employment and Productivity in a Woodworking Company (when cutting boards sell for $20 each)

Number of workers

Total number of cutting

boards/weekVMP

($/week)

MP(extra cuttingboards/week)

0 0

1 30

2 55

3 76

4 94

5 108

30 600

25 500

21 420

18 360

14 280

•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


Slide 10

MB MC


The Occupational Demand for Labor

Employment in firm 1(person-hours/day)

Wag

e ($

/ho

ur)

Employment in firm 2(person-hours/day)

Wag

e ($

/ho

ur)

D1 = VMP1 D2 = VMP2

6

12

100 150

6

12

50 100

+

+


Slide 11

MB MC


The Occupational Demand for Labor

Total Employment(person-hours/day)

Wag

e ($

/ho

ur)

D = VMP1 + VMP2

250150

6

12

=

=


Slide 12

MB MC


The Supply Curve of Labor

Employment of programmers(person-hours/year)

Wag

e ($

/ho

ur)

S

L2L1

W1

W2

• Supply for a specific occupation is upward-sloping.

• Supply for the economy may be vertical or downward-sloping.


Slide 13

MB MC


The Effect of an Increase in the Demand for Computer Programmers

Employment of programmers(person-hours/year)

Wag

e ($

/ho

ur)

S

L1

W1

D1

L2

W2

D2

• Changes in equilibrium W & Q occur when the supply and/or demand for labor changes.


Slide 14

MB MC


Explaining Differences in Earnings

When labor markets are competitive, differences in wages are determined by differences in VMPs.


Slide 15

MB MC


Explaining Differences in VMPsHuman 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.



Slide 16

MB MC


Explaining Differences in VMPsHuman Capital Theory

A theory of pay determination that says a worker’s wage will be proportional to his or her stock of human capital



Slide 17

MB MC


Explaining Differences in VMPsLabor Union

A group of workers who bargain collectively with employers for better wages and working conditions



Slide 18

MB MC


Explaining Differences in VMPsChanges in demand can influence the

value of human capital.



Slide 19

MB MC


An Economy with Two Nonunionized Labor Markets

Employment in market 1

Wag

e ($

/ho

ur)

Employment in market 2

Wag

e ($

/ho

ur)

125

9

75

9

D1 = VMP1 D2 = VMP2


Slide 20

MB MC


An Economy with Two Nonunionized Labor Markets

Total employment(workers/day)

Wag

e ($

/ho

ur)

S0

200

9

D = VMP1 + VMP2

• A nonunionized labor market

•W = $9 & Q = 200


Slide 21

MB MC


The Effect of a Union Wage Above the Equilibrium Wage

Employment in market 1(unionized market)

Wag

e ($

/ho

ur)

D1 = VMP1

125

WU = 12

Employment in market 2(nonunionized market)

Wag

e ($

/ho

ur)

75 100

D2 = VMP2

9

WN = 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


Slide 22

MB MC


Economic NaturalistIf unionized firms have to pay more, how

do they manage to survive in the face of competition from their nonunionized counterparts?



Slide 23

MB MC


Economic NaturalistUnionization may increase productivity by:

Allowing employers to set higher employment standards.

Improving communication.Improving morale.Reducing turnover.



Slide 24

MB MC


Economic NaturalistThe 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.



Slide 25

MB MC


Compensating Wage DifferentialsThe wage rate depends on the VMP and

the working conditions.



Slide 26

MB MC


Economic NaturalistWhy do some ad copy writers earn more

than others?



Slide 27

MB MC


Economic NaturalistWhich job would you choose?

Writing ad copy for the American Cancer Society or Camel cigarettes

o They both pay the same, $30,000/yro Both have the same prospects for advancement

How much would you have to be paid to switch?



Slide 28

MB MC


Economic NaturalistCornell Survey

90% chose the American Cancer SocietyMedian wage premium = $15,000



Slide 29

MB MC


Compensating Wage DifferentialThe differences in the wage rate -- positive

or negative -- that reflects the attractiveness of a job’s working conditions

ExamplesJob safety

o Police and fire-fighters

Scheduleso Day vs. nighto Teachers



Slide 30

MB MC


Discrimination in the Labor MarketCompetitive 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.



Slide 31

MB MC


Employer DiscriminationAn arbitrary preference by an employer for

one group of workers over another



Slide 32

MB MC


Discrimination by EmployersAssume

Male and female employees are equally productive.

An employer prefers to hire male employees.Male employees are paid more.



Slide 33

MB MC


Discrimination by EmployersThen:

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.



Slide 34

MB MC


Discrimination by OthersCustomer 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



Slide 35

MB MC


Other Sources of the Wage GapWillingness to accept riskQuality versus quantity of educationCourses taken and degrees pursued by

sex and race



Slide 36

MB MC


Winner-Take-All MarketsOne in which small differences in human

capital translate into large differences in pay



Slide 37

MB MC


Economic NaturalistWhy does Renee Fleming earn millions

more than sopranos of only slightly lesser ability?



Slide 38

MB MC


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 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


Slide 39

MB MC


Recent Trends in Inequality

ObservationsFrom 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.


Slide 40

MB MC


Recent Trends in Inequality

ObservationsIn 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.


Slide 41

MB MC


Is Income Inequalitya Moral Problem?

Choosing the Rules for Distributing IncomeAssume

A “veil of ignorance”National income is fixedMost people are risk adverse


Slide 42

MB MC



What Do You Think?How would people choose to allocate the

income?


Slide 43

MB MC



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?


Slide 44

MB MC



Rewards for hard work and risk taking raise national income.

Such rewards lead to inequality.


Slide 45

MB MC



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.”


Slide 46

MB MC


Methods of Income Redistribution

Difficulties in Developing Programs to Reduce Income InequalityIdentifying who will receive benefitsUndermining the incentive to work


Slide 47

MB MC



Welfare Payments and In-kind TransfersAssistance to the poor includes:

Cash transfersIn-kind transfers


Slide 48

MB MC



In-Kind TransferA payment made not in the form of cash,

but in the form of a good or service


Slide 49

MB MC



Welfare Payments and In-kind TransfersAid to Families with Dependent Children

(AFDC)Federal Cash Transfer ProgramCriticisms

o Created an incentive for the father to leave the household

o Reduced the incentive to work


Slide 50

MB MC



Welfare Payments and In-kind Transfers1996 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 benefitsDebatable on how successful the program has

been


Slide 51

MB MC



Means-Tested Benefit ProgramsBenefit level declines as the recipient

earns additional incomeMay make people better off if they do not

workCostly to administer


Slide 52

MB MC



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%.


Slide 53

MB MC



The Negative Income Tax (NIT)Advantages

Incentive to workLower administrative cost


Slide 54

MB MC



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 = $18,000Eight families pool their payments ($144,000)

and move to a rural location and produce their own food


Slide 55

MB MC



The Negative Income Tax (NIT)An Example

Creates and incentive not to workThe political cost is high because the NIT

guarantees income to all who do not work


Slide 56

MB MC


W

L0L1

Wmin

Unemployment

The Effect of Minimum Wage Legislation on Employment

Employment

Wag

e ($

/ho

ur)

S

D


Slide 57

MB MC


Employer surpluswithout minimum wage

Worker surpluswithoutminimum wage

Worker and Employer Surplus in an Unregulated Labor Market

L (person-hours/day)

W (

$/h

ou

r)

By how much will a minimum wage reduce total economic surplus?

S

D

5,000

5

10

10,0000


Slide 58

MB MC


The Effect of a Minimum Wageon Economic Surplus

S

W (

$/h

ou

r)

D

5,000

5

10

10,0003,000

3

7

L (person-hours/day)0

Employer surpluswith minimum wage

Worker surpluswith minimumwage

Reduction in total surpluscaused by minimum wage


Slide 59

MB MC



The Earned-Income Tax Credit (EITC)A policy under which low-income workers

receive credits on their federal income taxIn 2004, family of four with earned income

of $13,000 had an EITC of $4,000.


Slide 60

MB MC



ExampleUsing an Earned-Income Tax Credit

With no minimum wage, employment = 5,000 person-hours/day

Workers get paid $5/hrWorker surplus is $4,000/day less than with the

minimum wageThe tax credit would be $0.80/hr for 5,000

person hours/day


Slide 61

MB MC



ExampleIf the EITC were financed by a $4,000 tax

on employers, employer surplus would be $4,000 greater than under the $7 minimum wage.


Slide 62

MB MC



Public Employment for the PoorOvercomes the shortcomings of the EITC

and NITEITC does not help the unemployedNIT reduces the incentive to work


Slide 63

MB MC



Public Employment for the PoorDisadvantages of public service

employmentPeople may leave private sector jobs.The output created by the jobs may not have

any value.Increase in government bureaucracy.


Slide 64

MB MC



A Combination of MethodsUse a NIT with payment set below the

poverty thresholdSet the public service wage below the

minimum wagePrivatize the management of the public

service employment program


Slide 65

MB MC


NIT

Public Job

NIT + Public Job

NIT + Private Job

Income by Source in a Combination NIT – Jobs Program

Povertythreshold

MB MC

End ofChapterEnd of

Chapter

labor markets, poverty, and income distribution

Documents