Labor markets and income
distribution
Today: Value of work, human
capital, unions, discrimination,
and income distribution
Today: 5 mini-lectures about
labor markets

Value of work


Human capital


Direct effects and indirect effects
Discrimination


Training, education, experience, etc.
Unions


How much is labor worth?
What does theory tell us about discrimination?
Income distribution

Is income inequality a bad thing?
Value of work


Will every person get the same wage
for the same hour of work?
Maybe


It depends what the structure of the
market is
It depends on the marginal value of the
hour of work
Suppose a competitive labor
market

If each person’s hour of work results in
$50 in additional output, should each
worker get paid $50 per hour?


Not quite
You have to deduct the firm’s costs



Capital costs
Input costs
Transaction and handling costs
Simple example with input and
capital costs




I need $20 in supplies and one hour to
build a small cabinet
The firm I work for also needs to rent a
cubicle, at $8 per hour
Once I finish building the cabinet, the
firm can sell it to a wholesaler for $50
What is my worth to the company?
What is my worth to the
company?

The company is willing to pay up to $22 per
hour for my labor to build cabinets




Costs: $28 (supplies and cubicle)
Benefits: $50
In a competitive environment, if Firm X offers
less then $22, Firm Y can offer me more than
what Firm X does
The battling between Firms X and Y will
continue until one offers $22
Marginal product of labor



In this example, my marginal product
(MP) of an hour of labor is 1 cabinet
The value of my marginal product
(VMP) of an hour of labor is the
additional value my hour of work
produces: $22
All workers just like me will earn $22
per hour in a competitive labor market
Suppose that you could build
two cabinets per hour


Should you earn $22 per hour?
No



Costs per hour: $48 (Supplies for two
cabinets and one hour’s cubicle rental)
Benefits per hour: $100 (two cabinets)
You should earn $52 per hour for your
work
Back to an old example
# of empl./day
Phones per day
0
0
1
20
2
45
3
55
4
63
5
67
Recall the following
information



Phones sell for $18 each
Variable cost is $100 per worker
Only other costs are fixed
Different analysis, same result
Produce as long as VMP > $100
# of empl./day
Phones per day
0
0
1
2
3
4
5
MP (extra phones
per day)
VMP ($ per day)
20
360
Yes
25
450
Yes
10
180
Yes
8
144
Yes
4
72
No
Hire?
20
45
55
63
67
Recall this table from Lecture 6:
We hire 4 workers either way
# of empl./day
Phones per
day
0
0
1
2
3
4
5
MB ($/phone)
MC ($/phone)
18.00
5.00
18.00
4.00
18.00
10.00
18.00
12.50
18.00
25.00
20
45
55
63
67
When analyzing labor
problems…


You can often choose the method you
use to maximize a firm’s benefits
Notice that we get the same answer
either way
Summary: Value of work

In a competitive labor market, the longrun equilibrium wage is a worker’s VMP


More productive workers will get paid more
in a competitive environment equilibrium
Some labor problems that were
analyzed using the MB/MC approach
can also be analyzed using a VMP
approach
Human capital


Human capital comprises of the
characteristics that affect the value of
the person’s work when hired
The better the characteristics of human
capital, the more a person is likely to
earn
Some human capital qualities

Education





Direct knowledge
Intelligence
Signaling
Training
Work and life
experiences




Energy level
Work habits
Trustworthiness
Initiative
Education sends many messages
to a potential employer



“I have learned everything needed to finish this level
of education”
“I am intelligent enough to finish this education,
which probably means I am smarter than those
without my level of education”
“I am using this level of education to send a signal
that I have other good qualities that you are looking
for; others that do not finish this level of education
can say the same thing”
Education and employment

Many jobs require a minimum level of
education to be considered for a job


M.D. to be hired as a doctor
License for many specialized fields



Real estate
Pilot
High school or college diploma for many
entry-level jobs
Education and employment

The more education you have, the
higher you are in demand for your
services

Exceptions: People that get a Ph.D. in the
humanities often end up in the same type
of job that they had before
For more on education



See “Mandatory starting dates for
kindergarten,” p. 367
See Economic Naturalist 13.4, p. 387
A new class is being developed in the
Economics department
Summary: Human capital

Many characteristics form human capital


Education probably most important for
most people
Human capital is valued by employers
due to the fact that it increases a
workers productivity
Unions

Unions form so that workers can
collectively bargain


Wages
Working conditions
Unions and wages

Can anyone unionize and demand
higher wages?



In most cases, yes
Demands will not always be agreed to
As wage increases, the firm can employ
fewer people profitably
When are unions effective?

Finding qualified workers outside of a
union is difficult or impossible

Example: Writers’ strike



See “Additional reading” on class website for
more on this topic
When a firm is making economic profits
When a unionized firms can hire better
workers than nonunionized firms
Quote from writers’ strike
article

“In the world of labor negotiations
today, the writer of a hot TV show has
more power than an auto assembly
worker with a rivet gun.”
(From “Writers a rarity — a union with
power.” Posted 11/5/07. See
http://www.msnbc.msn.com/id/21598412/)
Why can writers form a
powerful union?



Few good outsourcing options
Requires specialized skills
Unionization of all writers means that
no writer will write for a show without
the union’s “blessing”

“Scabs” that write without the union’s
blessing during a strike are often unable to
obtain work once the strike is over
What can networks do to
combat the writers’ union?

More unscripted programming





Reality shows
Game shows
Sports
TV news magazines (60 Minutes, 20/20,
etc.)
“Specials” (Barbara Walters, concerts)
Summary: Unions

Unions can be effective in some
situations


When workers doing the same kind of job
are heterogeneous in human capital
When replacement workers cannot easily
be found


No good outsourcing options
Nobody outside of the union is able to do the
job
Discrimination



The “wage gap” between men and
women has been a hot topic for
decades
How much of this is due to
discrimination?
How much of this is due to other
factors?
Recall human capital theory


Human capital theory says that wages
are determined by factors such as
education and experience
Education likely to affect wage gap


Mid-20th century: More men than women
with college education
Today: 4 women graduate college for
every 3 men
The wage gap, declining

As more women enter the work force,
the wage gap declines


More women enter a job with the same
education as men
Despite changes in education, there is
still a wage gap
What else explains the wage
gap?

Holding constant important factors such
as occupation, education, field of
expertise, and years of experience

Men often choose majors with high salary
potential after graduation

Math, science
What else explains the wage
gap?

Customer discrimination

Examples



Lawyers
Physicians
Incorrect conclusions about the relative
productivity of men and women
Does discrimination actually
occur?


Probably
Likely due to the incorrect conclusions
about the productivity of men and
women
Does discrimination actually
occur?

Example of what might be occurring



Some managers may look at two
candidates for a promotion, one male, one
female
Both are nearly equally qualified
On paper, most managers would promote
the woman

90% of managers would promote the woman
based solely on human capital
Does discrimination actually
occur?


Some managers may have experiences from
the past that “women are family oriented”
and “men are career oriented”
Although today’s workforce is more
homogeneous than it used to be, some
managers may subconsciously favor the man
when the gender of both applicants is known

When gender of both is known, maybe only 30%
of managers promote the woman
Does discrimination actually
occur?

In jobs where men are mostly
managers, they may incorrectly weigh
human capital traits


High weight to human capital traits that
men have more of
Low weight to human capital traits that
women have more of
Does discrimination actually
occur?

What will happen when these managers “get
it wrong?”




Promotion of a lower-productivity worker
Lower productivity leads to lower profits
Lower profits lead to a higher likelihood that a
business in a perfectly competitive environment
will not survive in the long-run
Higher productivity worker may find a better job
at another firm
Does discrimination actually
occur?

Results of this example



When human capital differences are clear,
the best candidate will get the promotion
When human capital differences are not
clear, the promotion may be more likely to
go the male worker
Perfectly competitive firms that
discriminate are less likely to survive in the
long run
Summary: Discrimination

A wage gap between men and women’s
pay has existed for decades


Some of this can be explained by
controlling for education, experience, and
other factors
Some discrimination may be occurring

Firms that do discriminate based on factors
such as gender and race are less likely to
be competitive in the long run
Income distribution

Is income inequality a bad thing?


Some argue that people would prefer more
income equality
Others argue that economic incentives are
needed to keep the “economic pie” from
getting smaller
Mean income table (families),
from F/B, p. 411 (2000 dollars)
Quintile
1980
1990
2000
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

Real income growth, 1980-2000


Bottom 20% has been flat
Top 20% has seen huge growth (59%)
The gap between rich and
poor widens


The rich are getting richer, but the poor
are not getting poorer
The middle class has seen moderate
real growth in income

16-29% growth for the categories in the
middle 60%
The “veil of ignorance”

John Rawls, a moral philosopher, came
up with the following argument to
create income equality

“Veil of ignorance”



Conceals knowledge and talents from people
Risk averse people will want to have income
equality under these conditions
No inferiority, jealousy or envy based on
income
Problems with income
inequality

Those that are relatively poor may feel
inferior



This problem may perpetuate to their
children
Jealousy towards other people
Envy towards other people’s
accomplishments
Problem: The “economic pie”
will shrink with Rawls’ ideas

If income was guaranteed to be equal
to everyone, nobody will have an
economic incentive to gain human
capital

Smaller “economic pie”


Less human capital
People work less
Is there an optimal amount of
income inequality?


Impossible to answer
Different people have different opinions
about effectiveness of realistic ways to
redistribute income
Some methods of income
redistribution (& their problems)

Welfare payments


Little economic incentive to get off of
welfare without time limits
Negative income tax

Incentive to work for pay diminishes
Some methods of income
redistribution (& their problems)

Minimum wage


Unemployment
Public employment of the unemployed


Needs to have enough incentives for
unemployed people to want to work
Needs to have incentives low enough for
employed people to stay in their old job
A success story of
income redistribution

The earned-income tax credit (EITC)


The “working poor” receive a sizable credit
for working and making an income in a
given range
Essentially a negative income tax for those
working and making low incomes
Summary: Income
distribution

In recent decades, income inequality has
grown



Due mostly to large real growth in upper income
groups
Income equality is a moral issue, but with
many costs when implemented
The EITC is a success story of balancing
income redistribution and economic
incentives