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Wage Determination
14
Wage Determination
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
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What Do You Want
In Life?
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
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title
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Of Living
 What is it?
 Per Investopedia
 The level of wealth, comfort, material goods and
necessities available to a certain socioeconomic class
in a certain geographic area.
 The standard of living includes factors such as
income, quality and availability of employment, class
disparity, poverty rate, quality and affordability of
housing, hours of work required to purchase
necessities, gross domestic product, inflation rate,
number of vacation days per year,
 The standard of living is closely related to quality of
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What Do You Want?
What standard of living do you want for
yourself?
 Better,
 the same
 or worse than your parents?
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Do you Think
How do you reach your goal of a better
standard of living?




Little work for little pay
Little work for high pay?
Hard work for little pay?
Hard work for high pay?
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All Related To Income
All of this from the previous slide are related
to Income








Quality and availability of employment
Class disparity
Poverty rate
Quality and affordability of housing
Hours of work required to purchase necessities
Gross domestic product
Inflation rate
Number of vacation days per year
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So how do you make income?
 Work
At what?
Research: What jobs pay the highest
income?
Which are related to education
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To be sure, the recession has hit unevenly,
with lower-skilled and less-educated
Americans feeling the pinch the most, says
Mark Zandi, chief economist for Moody's
Economy.com based in West Chester, Pa.
Many found their jobs gone for good as
companies moved production offshore or
bought equipment that replaced manpower.
"The pace of change has been incredibly
rapid and incredibly tough on the less
educated," says Mr. Zandi, who calls this
period the most difficult for American
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Education does not necessarily mean college
 Engineering degree vs. Liberal Arts degree
 Certified Automotive mechanic vs. High School
Education
Click Your
to editCompetition
Master title style
Not just next to you
We are in a global economy
You competition is also overseas
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China: World's Largest Supplier Of
Educated Workers
By 2030, China alone will account for 30
percent of the world's new college-educated
workers, predicts a study by the McKinsey
Global Institute.
In comparison, the United States will
account for only 5 percent, and collectively,
advanced countries including the U.S.,
Japan and much of Europe will account for
only 14 percent of new highly educated
Click to edit Master title style
"Investments in education that China made
much earlier are now paying off," said Anu
Madgavkar, a senior fellow for the McKinsey
Global Institute. "China invested in opening
a lot of schools and they ramped up college
enrollment.“
Click to edit Master title style
China is also churning out far more science,
technology, engineering and mathematics
grads, giving it a leg up in some of the
world's fastest growing sectors.
In 2012, only 14 percent of U.S. grads earned
degrees in those specialties, whereas 42% of
China's college grads did so.
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What Decisions Are You Making?
What decisions are you making for yourself?
Click to editGoals
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Differentiate between nominal and real
wages.
List those factors that have led to an
increasing level of real wages in the U.S.
historically.
 Non necessarily in the last eight years
Determine the equilibrium wage rate
 employment level
• when given appropriate data for a firm operating in a
purely competitive
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Goals
Illustrate graphically how wage rates are
determined in
 purely competitive
 monopolistic labor markets.
List the methods used by labor organizations
 to increase wages
 and the impact each has on employment.
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goals
Illustrate graphically how an inclusive
(industrial) union and an exclusive (craft)
union would impact
 wages and employment in a previously
competitive labor market.
Explain and illustrate graphically wage
determination
 In the bilateral monopoly model.
Present the major points in the cases for and
against the minimum wage.
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Goals
Explain the demand factors that create wage
differentials.
Explain the supply factors that create wage
differentials.
Describe briefly salary systems in which pay
is linked to performance rather than to time.
Describe the negative side effects of poorly
planned incentive pay plans.
Define and identify terms and concepts
listed at the end of the chapter.
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What Do You Want In
Life?
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
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I’ll tell ya what I want
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Of Living
• What is it?
• Per Investopedia
– The level of wealth, comfort, material goods and
necessities available to a certain socioeconomic class in a
certain geographic area.
– The standard of living includes factors such as income,
quality and availability of employment, class disparity,
poverty rate, quality and affordability of housing, hours
of work required to purchase necessities, gross domestic
product, inflation rate, number of vacation days per year,
– The standard of living is closely related to quality of life.
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Medium Income by State
Neshaminy demographics
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How can someone “earn money” or income
Wages
• Salary , hourly, piece work






Commission
Royalties
Interest
Dividends
Rent
Profits
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Other Forms Of Compensation
Benefits
 Health
 Dental
 Eye
Vacation
Stock options
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What can you conclude from the previous
slides?
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All of this from the previous slide are related
to Income









quality and availability of employment
class disparity
poverty rate
quality and affordability of housing
hours of work required to purchase necessities
gross domestic product
inflation rate
number of vacation days per year
Life expectancy
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How long would you like to live?
One of the largest determinants (overall) of
life expectancy is---
Add
These
Numbers
25 For
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Expectancy
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Top Paying Careers In US
Top paying careers
 What are the top paying careers?
• Research!!!
Myplan.com top paying careers
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Highest Paid Careers
Doctors’ salaries are so high not only
because of supply and demand but also to
offset the amounts they have to invest in
education and malpractice insurance. The
33,310 anesthesiologists in the U.S. also
work long shifts and play an integral role in
keeping patients alive during surgery to earn
their sizable salaries. The high pay reflects
the responsibility and risk involved in their
job.
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Paid Work
The lowest-paid workers, fast food cooks,
earn $9 an hour, for an average annual salary
of $18,720. More than a half million people
in the U.S. hold this position, and another
2.8 million are in a food preparation and
serving job, the second worst-paying
occupation. Dishwashers and shampooers
trail close behind, making a meager $18,840
and $19,130 a year, respectively.
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So how do you make depends in large part
on--Almost all are related to education
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Not Fair
Get used to it!!!
Only about 25% to 30% of students
graduating today will earn a college degree
(in 6 years)
 30% ± drop out of HS
 0f those 70± remaining, 60% go to college (42
students)
 Of those, 40±% do not finish in 6 years
• Some go back as adults to start/finish
• National Center For Education Statistics
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• To be sure, the recession has hit unevenly,
with lower-skilled and less-educated
Americans feeling the pinch the most, says
Mark Zandi, chief economist for Moody's
Economy.com based in West Chester, Pa.
Many found their jobs gone for good as
companies moved production offshore or
bought equipment that replaced
manpower.
• "The pace of change has been incredibly
rapid and incredibly tough on the less
Click to edit Master title style
Education does not necessarily mean college
 Engineering degree vs. Liberal Arts degree
 Certified Automotive mechanic vs. High School
Education
Click Your
to editcompetition
Master title style
Not just next to you
We are in a global economy
You competition is also overseas
Click to edit Master title style
• China: World's Largest Supplier Of
Educated Workers
• By 2030, China alone will account for 30
percent of the world's new college-educated
workers, predicts a study by the McKinsey
Global Institute.
• In comparison, the United States will
account for only 5 percent, and collectively,
advanced countries including the U.S.,
Japan and much of Europe will account for
only 14 percent of new highly educated
Click to edit Master title style
"Investments in education that China made
much earlier are now paying off," said Anu
Madgavkar, a senior fellow for the McKinsey
Global Institute. "China invested in opening
a lot of schools and they ramped up college
enrollment.“
Click to edit Master title style
China is also churning out far more science,
technology, engineering and mathematics
grads, giving it a leg up in some of the
world's fastest growing sectors.
In 2008, only 14 percent of U.S. grads
earned degrees in those specialties, whereas
42% of China's college grads did so.
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What Decisions Are You Making?
What decisions are you making for yourself?
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Elements To Higher Wages
Education
 The “right” education
Skills
Hard work
Supply and demand for a particular position
None of these are a guarantee for high wages
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Apply Supply & Demand To Wages
What happens-- Why can you work in the Perdoe Bay and make
$100,000 a year or more?
 Why can you move to North Dakota an make
$100,000 without a college degree
 Why do Walmart workers barely make
minimum wage?
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Unemployment rates impact wages
 Why and how?
 Graph any job using Supply and Demand
• High unemployment
• Low unemployment
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Labor, Wages ,and Earnings
Wages
 Price paid for labor
 Direct pay plus fringe benefits
Wage rate
 Price per unit paid
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What happens when
 Supply & Demand changes in the labor market?
• graph it
• Wage increases but no increase in productivity
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1. What happens when demand for labor
drops? (2 consequences)
2. How is lower quantity demanded for labor
accounted for on the graph, what happens?
3. Why don’t wages drop even more?
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Labor, Wages ,and Earnings
Nominal wage
 Amount of money received per hour
Real wage
 Quantity of goods or services a worker can
purchase
 With a nominal wage
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Real wages only increase if nominal wages
increase faster than the inflation rate.
If prices increase faster than nominal wages,
real wages will fall.
 This has happened for last 5+ years
Over the last 5 years, real wages for the
lowest 70% of educated in US
 Have fallen!!!
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Wages And Employment
For most, labor market is only source of
income
 We work and earn a wage
But: What determines the amount of labor we
supply?
What determines the amount of wages will be
paid?
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Role Of Productivity
Demand for labor (or any resource) depends
on productivity
Generally
 The greater the productivity of labor
 The greater the demand for labor
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Research and answer:
 What is productivity?
 How is productivity measured?
Click to Productivity
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Research and answer:
 What is productivity?
 How is productivity measured?
Productivity is a measure of production,
both output and input
 Inputs
• Labor and capital
 Outputs
• Generally a product of service
 It is measures as a ratio and can be positive or
negative
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Activity
It is measured as a ratio and can be positive
or negative
Activity: How productive are you at typing?
Go to:
www.typeonline.co.uk/typingspeed.php
Free online touch typing test
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 Income for most people is determined by
 Market value of the productive resources they sell
 What workers earn depends primarily on
• the market value of what they produce
• and how productive they are.
 People can earn income by exchanging
 their human resources (physical or mental work)
 for wages or salaries.
 Employers are willing to pay wages and salaries to
workers
 because they expect to sell the goods and services those
workers produce at prices high enough to cover the
wages and salaries and all other costs of production.
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Employers are willing to pay wages and
salaries to workers
 because they expect to sell the goods and
services those workers produce
 at prices high enough to cover the wages and
salaries
 and all other costs of production.
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A wage or salary is the price of labor
 it usually is determined by the supply of and
demand for labor.
More productive workers are likely
 to be of greater value to employers
 and earn higher wages than less productive
workers.
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In a labor market,
 In the absence of other changes,
 if wage or salary payments increase,
 workers will increase the quantity of labor they
supply
 and firms will decrease the quantity of labor
they demand.
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Changes in the prices of productive
resources affect
 the incomes of the owners of those productive
resources
 and the combination of those resources used by
firms.
Changes in demand for specific goods and
services
 often affect the incomes of the workers who
make those goods and services.
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Role Of Productivity
Demand for labor in advanced economies is
large
 Because labor is highly productive
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Real Wages and Productivity
Generally a close relationship
 Productivity needs to go up to pay higher wages
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Answer On a Sheet Of Paper
How many words can you type a minute?
How many words can you read per minute
(and retain)?
How many lines of programming code can
you write per day?
What ideas do you have to make the
company more money?
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Example
Productivity and revenue are closely tied
If productivity falls one can generally
conclude revenue falls
Companies build economic business model
on productivity and expenses
What are results of falling productivity?
 Often layoffs (demonstrate on board)
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Real income and real output are two ways of
looking at the same thing
Per worker compensation can only increase
 At about same rate as productivity or output per
worker
 Historically there is a close correlation
between the two
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Gross Domestic Product
The market value of all officially recognized
final goods and services produced
 within a country
 in a given period of time.
GDP per capita is often considered an
indicator of a country's standard of living
 GDP per capita is not a measure of personal
income
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Under economic theory,
 GDP per capita exactly equals the gross
domestic income per capita
 Human Capital theory states people with
higher education are more productive or
contribute to GDP more than less educated
workers.
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If productivity has increased significantly, as
shown in the previous graph, What has
happened to the additional profits earned
through productivity?
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Can you draw some general conclusions
from these graphs?
What conclusions did you draw?
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Personal Productivity
Look at your personal productivity factors
You are late = you are not as productive as
someone on time
How much time do you spend “playing” on
the internet, non productive purposes?
Examine personal productivity
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Role Of Productivity
Plentiful capital
Access to abundant natural resources
Advanced technology
Labor quality
Other factors
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Role Of Productivity
Plentiful capital
 Physical
 Money
Access to natural resources
 Available in large quantities
 In relation to labor force
Advanced technology
 Available capital is also advanced
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Role Of Productivity
Labor quality




Healthy
Vigorous (motivated)
Educated
High quality training
Therefore, tend to be efficient
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Other factors




Efficiency of management
Business
Social and political environment
Increased specialization
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Real Wages and Productivity
Generally a close relationship
Real income and real output are two ways of
looking at the same thing
Per worker compensation can only increase
 At about same rate as productivity or output per
worker
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Real Wages and Productivity
Real world, suppliers of
 land,
 capital
 talent
• also share in profits (today; disproportional)
Therefore, real wages do not always rise the
same as productivity
Over short periods of time
Over long term, productivity and real wages
tend to rise together
Click to Productivity
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Write: Answer
 What makes you personally productive?
 What would make you a more productive
citizen?
Homework: Productivity Analysis:
 Track how you spend your time after school
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Unemployment rates impact wages
 Why or how?
 Graph any job using Supply and Demand
• High unemployment
• Low unemployment
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Output is increasing
 Compensation not keeping pace
 WHY? Where are the increases in productivity
(money) going?
 We are now going full circle to the beginning of
the year
 Research: Start with Huffington Report
• Wages aren’t keeping up with US Productivity
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Real to
Wages
Productivity
LO1
13-93
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20% of the
people control
92% of the
wealth in the
United States
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Click to Productivity
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Answer
 What makes you personally productive?
 What would make you a more productive
citizen?
 What did your Productivity analysis show you
about you?
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Real Wages and Productivity
History repeats itself
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 Ford Motor Company made headlines in 1914 by offering autoworkers $5 per day, up from
$2.50 per day. The wage payment was newsworthy because the typical market wage in
manufacturing at that time was just $2 to $3 per day.



What was Ford’s rationale for offering a higher-than-competitive wage? Statistics
indicate that the firm was suffering from high rates of job quitting and absenteeism. It
reasoned that a high wage rate would increase worker productivity by increasing morale and
reducing employment turnover.
Only workers who worked at Ford for at least six
months were eligible for the $5 per day wage.
Nevertheless, 10,000 workers sought jobs
with Ford in the immediate period following the announcement of the wage increase.
According to historians, the Ford strategy succeeded. The $5 wage raised the value of
the job to Ford workers. That created worker incentives to maintain employment at Ford
and show up for work each day. It also encouraged laborers to work energetically so as not to
be fired from a job that paid much more than alternative employment. The rates of job
quitting and absenteeism both plummeted, and labor productivity at Ford rose by an
estimated 51 percent that year.
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 The $5 wage was an efficiency wage—one that raised the
marginal revenue product of Ford workers. Ford’s pay
plan addressed its principal-agent problem. The $2.50
wage hike “paid for itself” by more closely aligning the
interests of Ford workers and owners.

 1 This application is from Campbell R. McConnell, Stanley
L. Brue, and David A. Macpherson, Contemporary Labor
Economics, 5th ed. (New York: McGraw-Hill, 1999), p.
233. It is based in part on Daniel M. G. Raff and Lawrence
Summers, “Did Henry Ford Pay Efficiency Wages?”
Journal of Labor Economics, pt. 2, October 1987, pp. S57S86.
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 Barely a week after coming out in favor of
increasing the federal minimum wage to $10.10,
Costco CEO Craig Jelinek reported that his
company posted profits of $537 million for the last
quarter. That’s up from $394 million last year. “At
Costco,” Jelinek said, “we know that paying
employees good wages makes good sense for
business.” He went on to elaborate that “We know
it’s a lot more profitable in the long term to
minimize employee turnover and maximize
employee productivity, commitment and loyalty.”
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Of Labor
People supply labor to earn income
Many factors influence the quantity of labor
 What a person provides
•
•
•
•
Knowledge
Motivation
Creativity
Skills
 KEY factor is wage rate
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WAGES AND EMPLOYMENT
The Supply of Labor
 People supply labor to earn an income.
 Many factors influence the quantity of labor that
a person plans to provide,
• but the wage rate is a key factor.
 Figure on the next slide shows an individual’s
labor supply curve.
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WAGES AND EMPLOYMENT
The table shows
Larry’s labor supply
schedule, which is
plotted in the figure
as Larry’s labor
supply curve.
Click to edit Master title style
Productivity, which measures the goods and
services generated per hour worked
 Rose by 80.4% between 1973 and 2011
 Compared to a 10.7% growth in median hourly
compensation
This factors ALL compensation
Rose more for educated workers
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WAGES AND EMPLOYMENT
 Influences on the Supply of Labor
 Key factors influence the supply of labor:
• Wages
• Current
• Expected future
• Adult population (willing to work)
• Preferences
• Time in school
• Training
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WAGES AND EMPLOYMENT
Adult Population
An increase in the adult population increases the
supply of labor.
Preferences
There has been a large increase in the supply of
female labor since 1960.
The percentage of men with jobs has shrunk
slightly.
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WAGES AND EMPLOYMENT
Time in School and Training
The more people who remain in school for fulltime education and training,
•the smaller is the supply of low-skilled labor.
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US has fallen behind some nations in its
college educated population
 What does this mean for the US economy?
 What will happen to US wages and the
difference between the people with money and
the people without money?
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Global
LO1
13-112
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WAGES AND EMPLOYMENT
The table shows
Larry’s labor supply
schedule, which is
plotted in the figure
as Larry’s labor
supply curve.
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WAGES AND EMPLOYMENT
1. At a wage rate of
$10.50 an hour,
Larry …
2. …supplies 30
hours of labor a
week.
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WAGES AND EMPLOYMENT
3. As the wage rate
rises, Larry’s
quantity of labor
supplied …
4. …increases,
5. …reaches a
maximum, …
6. …then
decreases.
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WAGES AND EMPLOYMENT
This supply curve
shows how the
quantity of car wash
workers supplied
changes when the
wage rate changes,
other things
remaining the same.
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Minimum Wage
1. What is minimum wage?
2. Is minimum wage free market? Why or
why not?
3. Should we have a minimum wage?
4. If we should have a minimum wage, should
the minimum wage be increased?
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Inflation and Real Wage Increases
If inflation runs at 2%
Wage increases are 3%
Real wage increases are 1%
 Increase in purchasing power
If inflation is 3%
Wage increases are 2%
Real wages increases are a negative 1%
 Loss of buying power
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What is a Labor Union?
 An association, combination, or organization
of employees
 Who band together to secure favorable
1.
2.
3.
4.
Wages
Improved working conditions,
Better work hours
And to resolve grievances against employers.
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Craft Union Model
Effectively reduce supply of labor
 Restrict immigration
 Reduce child labor
 Compulsory retirement
 Shorter workweek
Exclusive unionism
Occupational licensing
LO4
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Craft Union Model
Wage Rate (Dollars)
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Decrease
In Supply
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Quantity of Labor
LO4
13-133
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Industrial Union Model
Inclusive unionism
 Auto and steel workers
Wage Rate (Dollars)
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Quantity of Labor
LO4
13-134
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Test
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Demand Enhancement
Q. Why would a union fight a companies
attempts to increase productivity?
 Example: “through use of robots”
A: Increases in productivity could mean less
union workers needed.
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Increase Productivity
Generally management makes decisions
Unions want a say
Often are brought in to get “buy in”
Can sometimes mean the difference between
some jobs or no jobs
 Ford factory in Brazil not US
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Craft Union Model
Effectively reduce supply of labor
 Restrict immigration
 Reduce child labor
 Compulsory retirement
 Shorter workweek
Exclusive unionism
Occupational licensing
LO4
13-150
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Craft Union Model
Wage Rate (Dollars)
S2
S1
Decrease
In Supply
Wu
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Qu
Qc
Quantity of Labor
LO4
13-151
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Inclusive or Industrial Union Model
Attempt to unionize all workers
 Auto and steel trucking
Can put immense pressure on industry
 Can strike en mass
• Teamsters in the 60’s
• Transit in Philadelphia 40’s
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Industrial Union Model
Inclusive unionism
 Auto and steel workers
Wage Rate (Dollars)
S
Wu
a
b
e
Wc
D
Qu
Qc
Qe
Quantity of Labor
LO4
13-153
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Craft Union Model
Effectively reduce supply of labor
 Restrict immigration
 Reduce child labor
 Compulsory retirement
 Shorter workweek
Exclusive unionism
Occupational licensing
LO4
13-154
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Models
Are unions successful?
 Wages 15% higher on average
Consequences:
 Higher unemployment
 Restricted ability to demand higher
wages
LO4
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US participation peaked in 50’s/60’s at
30+%
Now sits at 11% ± and is declining
Most union members are now in public
sector
 Philadelphia and New York are two strongholds
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Answer
Given these factors, why do you think the
economic impact of unions is diminished
and the number of workers covered by
unions has been shrinking since the late
1950’s?
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The Minimum Wage Controversy
Case against minimum wage
Case for minimum wage
State and locally set rates
Evidence and conclusions
LO5
13-162
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Minimum Wage
Current minimum wage
 $7.25 per hour
Tend to be industries that make only a few
cents per dollar profit
Generally young workers or undereducated
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From
U.S. Minimum Wage Workforce by Age,
2006-2011
 http://www.scribd.com/doc/89221883/U-S-MinimumWage-Workforce-by-Age-2006-2011
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Answer
1. Why do you think the number of
minimum wage earners (as a general
observation) increases in the first two age
groups?
2. Why do you think the percentage of
minimum wage earners decreases with age
after the age of 24?
3. Does raising the minimum wage cause
unemployment?
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Discuss
Washington Post article on
 Five Myths About Minimum Wage
Business Insider
 If you raise minimum wage and it does not raise
unemployment, you didn’t raise it enough
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Minimum Wage Statistics
Since 2006, number of minimum wage
earners has doubled
 From 1.69 million to 3.83 million
Why do you believe this happened?
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Research
What are five reasons to raise minimum
wage?
What are five reasons to NOT raise
minimum wage?
What is your opinion and WHY?
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What Are Wage Differentials?
Differences in pay
Where do wage differentials exist?





Job functions or descriptions
Ability
Geography
Gender?
Ethnicity?
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Wage
Workers prevented from moving to
higher paying jobs
Market imperfections
 Lack of job information
 Geographic immobility
 Unions and government restraints
 Discrimination
LO5
13-174
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LO5
13-177
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Principal Agent Problem
The principal-agent problem
Research: what is the Principal Agent
problem?
Where does the Principal Agent
problem exist?
LO6
13-178
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Principal Agent Problem
What is the Principal Agent problem?
 The principle agent problem arises when one party


(agent) agrees to work in favor of another party
(principle) in return for some incentives.
For various reasons, self interest, greed or feeling of
underpayment
the agent might begin to pursue his own agenda and
ignore the best interest of the principle, thereby causing
the principal agent problem to occur.
Where does the Principal Agent problem exist?
Do all agents and principles have this problem?
Why?
LO6
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Principal Agent Problem
Where does the Principal Agent problem exist?
 Corporations
• Agent(s) - CEO /management with principal being stock
holders
 Politics
• We elect someone to act on our behalf and the act on
behalf of special interest groups
 Business, care providers:
• May order tests/procedures to benefit them rather
than the patient
Do all agents and principles have this problem?
Why?
LO6
13-180
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Principal Agent Problem
Do all agents and principles have this problem?
Why?
 No
 Why?
 Not everyone acts in their own self interest alone.
LO6
13-181
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Principal Agent Problem
The principal-agent problem created
by
 Incentive pay plan
• Piece rates
• Commissions or royalties
• Bonuses, stock options, and profit
sharing
• Efficiency wages
Negative side-effects
LO6
13-182
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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
LO6
13-183
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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
LO6
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Discussion
Are CEOs as well as superstars in the sports
and entertainment industry are overpaid?
Why or why not?