McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

WageDetermination

Chapter 13

Chapter Objectives• Labor productivity and real

compensation • Wage and employment

determination • Competitive and monopsony

markets• Unions and wage rates• Causes of wage differentials• “Pay-for-Performance” plans

13-2

Labor Wages and Earnings

• Wages–Price paid for labor–Direct pay plus fringe benefits

• Wage rate• Nominal wage• Real wage• General level of wages

13-3

Level of Wages Across Nations

Hourly Wages of Production WorkersHourly Pay in U.S. Dollars, 2006

Source: U.S. Bureau of Labor Statistics, 2006

GermanySweden

SwitzerlandUnited Kingdom

AustraliaCanada

ItalyFrance

United StatesJapanSpainKorea

TaiwanMexico

0 5 10 15 20 25 30 35

13-4

Role of Productivity

• Labor demand depends on productivity

• U.S. labor highly productive–Plentiful capital–Access to abundant natural

resources–Advanced technology–Labor quality–Other factors

13-5

Real Wages

• Long run trend of average real wages in the U.S.–Variation across occupations

Rea

l Wag

e R

ate

(Dol

lars

)

Quantity of Labor

D1900

S1900

D1950

D2000D2020

S1950

S2000

S2020

13-6

Competitive Labor Market

• Market demand for labor–Sum of firm demand–Example: carpenters

• Market supply for labor–Upward sloping–Competition among industries

• Labor market equilibrium–MRP = MRC rule

13-7

Wag

e R

ate

(Dol

lars

)

Wag

e R

ate

(Dol

lars

)

($10)WC

($10)WC

Labor Market Individual Firm

Quantity of Labor Quantity of Labor

QC(1000)

0 0

D=MRP(∑ mrp’s) d=mrp

qC(5)

s=MRC

S

e

c

b

a

Competitive Labor Market

13-8

Monopsony Model

• Employer has buying power• Characteristics

–Single buyer–Labor immobile–Firm “wage maker”

• Firm labor supply upward sloping• MRC higher than wage rate• Equilibrium

13-9

Wag

e R

ate

(Dol

lars

)

Quantity of Labor

0

S

MRP

MRC

c

b

aWc

Wm

Qm Qc

• Examples of monopsony power

Monopsony Model

13-10

Demand Enhancement Model• Union model

–Increase product demand–Alter price of other inputs

Wag

e R

ate

(Dol

lars

)

Quantity of Labor

Wu

Qc Qu

Wc

D1

D2

S

IncreaseIn Demand

13-11

Craft Union Model

• Effectively reduce supply labor–Restrict immigration–Reduce child labor–Compulsory retirement–Shorter workweek

• Exclusive unionism• Occupational licensing

13-12

Wag

e R

ate

(Dol

lars

)

Quantity of Labor

D

S1

Qc

Wc

S2

Wu

Qu

DecreaseIn Supply

Craft Union Model

13-13

Industrial Union Model• Inclusive unionism

–Auto and steel workersW

age

Rat

e (D

olla

rs)

Quantity of Labor

D

S

Qc

Wc

Wu

Qu Qe

a be

13-14

Union Models

• Are unions successful?• Wages 15% higher on average• Consequences:

–Higher unemployment–Restricted ability to demand higher

wages

13-15

Bilateral Monopoly

• Monopsony and inclusive unionism

• Single buyer and seller• Not uncommon• Indeterminate outcome• Desirability

13-16

Bilateral Monopoly

Wag

e R

ate

(Dol

lars

)

Quantity of Labor

D=MRP

S

Qc

Wc

Wu

Qu=Qm

MRC

Wm

a

13-17

Minimum Wage

• Case against minimum wage• Case for minimum wage• State and locally set rates• Evidence and conclusions

13-18

Wage DifferentialsAverage Annual Wages, 2007

SurgeonsAircraft PilotsPetroleum EngineersFinancial ManagersLaw ProfessorsChemical EngineersDental HygienistsRegistered NursesPolice OfficersElectriciansTravel AgentsBarbersRetail SalespersonsRecreation WorkersTeacher AidesFast Food Cooks

$191,410148,810113,890106,20095,51084,24064,91062,48050,67048,10032,19025,86024,53023,79022,82016,860

Source: Bureau of Labor Statistics, 2006

Occupation Annual Average Wages

13-19

Labor Supply and Demand

• Differences across occupations• Explains wage differentials• Marginal revenue productivity• Noncompeting groups

–Ability–Education and training

• Compensating differences13-20

Education and Annual Earnings

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

18-24 25-34 35-44 45-54 55-64 65+

EducationalAttainment

Ann

ual E

arni

ngs

(Tho

usan

ds o

f Dol

lars

)

Age

Professional Degree

Bachelor’s Degree

Associate’s Degree

High School Diploma

13-21

Wage Differentials

• Workers prevented from moving to higher paying jobs

• Market imperfections–Lack of job information–Geographic immobility–Unions and government restraints–Discrimination

13-22

Pay for Performance

• The principal-agent problem –Incentive pay plan–Piece rates–Commissions or royalties–Bonuses, stock options, and profit

Sharing–Efficiency wages

• Negative side-effects

13-23

Are CEOs Overpaid?

• U.S. CEO salaries relatively high• Good decisions enhance productivity• Limited supply, high MRP• Incentive to raise productivity at all

levels• High salary bias by board members • Unsettled issue

13-24

Key Terms• wage rate

• nominal wage

• real wage

• purely competitive labor market

• monopsony

• exclusive unionism

• occupational licensing

• inclusive unionism

• bilateral monopoly

• minimum wage

• wage differentials

• marginal revenue productivity

• noncompeting groups

• human capital

• compensating differences

• incentive pay plan

13-25

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Rent, Interest,and Profit

13-26