Labor markets and income distribution

1. Labor markets and income distribution Today: Value of work, human capital, unions, discrimination, and income distribution

2. Today: 5 mini-lectures about labor markets • Value of work • How much is labor worth? • Human capital • Training, education, experience, etc. • Unions • Direct effects and indirect effects • Discrimination • What does theory tell us about discrimination? • Income distribution • Is income inequality a bad thing?

3. 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

4. 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

5. 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?

6. 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

7. 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

8. 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

9. Back to an old example

10. Recall the following information • Phones sell for $18 each • Variable cost is $100 per worker • Only other costs are fixed

11. Different analysis, same resultProduce as long as VMP > $100 Hire? Yes Yes Yes Yes No

12. Recall this table from Lecture 6: We hire 4 workers either way

13. 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

14. Summary: Value of work • In a competitive labor market, the long-run 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

15. 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

16. Education Direct knowledge Intelligence Signaling Training Work and life experiences Energy level Work habits Trustworthiness Initiative Some human capital qualities

17. 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 probablymeans 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”

18. 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

19. 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

20. 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

21. 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

22. Unions • Unions form so that workers can collectively bargain • Wages • Working conditions

23. 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

24. 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

25. 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/)

26. 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

27. 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)

28. 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

29. 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?

30. 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

31. 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

32. 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

33. What else explains the wage gap? • Customer discrimination • Examples • Lawyers • Physicians • Incorrect conclusions about the relative productivity of men and women

34. Does discrimination actually occur? • Probably • Likely due to the incorrect conclusions about the productivity of men and women

35. 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

36. 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

37. 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

38. 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

39. 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

40. 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

41. 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

42. Mean income table (families), from F/B, p. 411 (2000 dollars) • Real income growth, 1980-2000 • Bottom 20% has been flat • Top 20% has seen huge growth (59%)

43. 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%

44. 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

45. 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

46. 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

47. Is there an optimal amount of income inequality? • Impossible to answer • Different people have different opinions about effectiveness of realistic ways to redistribute income

48. 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

49. 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

50. A success story ofincome 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