Understanding Income Dynamics: Labor Supply & Earnings Differentials

1. ECONOMICS: EXPLORE & APPLYby Ayers and Collinge Chapter 23“Earnings and Income Distribution”

2. Learning Objectives • Relate the importance of wages and salaries. • Analyze why higher wages can lead an individual to prefer either more or fewer work hours. • List and explain the many causes of earnings differentials. • Assess the extent and significance of poverty and earnings differentials.

3. Learning Objectives • Discuss significant differences between the types of income – wages, rent, interest, and profit. • Discuss the life cycle of earnings through the use of the age/earnings profile.

4. 23.1MEASURING INCOMES • Wages are the incomes workers earn from their jobs. • The size of their incomes depends on two variables. • The quantity of labor they supply. • The amount they are paid. • The price of labor is the wage rate, the amount an individual is paid per hour. • When the wage rate is multiplied by hours worked, the result is earnings.

5. U.S. National Income

6. 23.2INDIVIDUAL LABOR SUPPLY The reservation wage is the wage below which individuals choose not to work at all (i.e., they “reserve” their labor). Unlike supply curves for other things, the individual’s supply curve of labor services has a backward bending portion. The substitution effect, and the income effect explain the backward-bending portion of the individuals supply curve of labor services

7. Labor Supply Curve Labor Supply Wage Rate Reservation Wage Quantity of Labor

8. Income and Substitution Effects • Substitution Effect:As wages rise, individuals will seek to work more - substituting away from leisure - because the opportunity cost of leisure becomes higher as wage rates rise. • Income Effect:As wages rise, higher wages bring higher incomes, which lead workers to demand more of all normal goods. Leisure is a normal good and, in order to “buy” more leisure, workers pay the opportunity cost of giving up the income from some work hours.

9. Income Effect Dominates Substitution Effect Dominates Income and Substitution Effects Labor Supply Wage Rate Reservation Wage Quantity of Labor

10. Change in Reservation Wage Effect of a Decrease in Non-labor Income Supply if less income from other sources Initial Supply Wage Rate Quantity of Labor

11. 23.3SOURCES OF EARNINGS DIFFERENTIALS • Different jobs have their own advantages and disadvantages. • Safe jobs are more attractive than dangerous jobs. • Higher pay in the latter jobs, can equalize their attractiveness relative to the former jobs. • Such increases are in pay are termed compensating differences.

12. Explaining Labor Differentials Occupational choice Compensating wage differentials Unions Human capital Discrimination Luck and other factors

13. Labor Unions • Workers join labor unions to improve their pay and work environments. • The decline in overall union membership mask the overall concentration of union membership in several key industries. • Global competition is probably the most important factor behind the low percentage of union workers in the economy.

14. Labor Unions • Once a union is certified, a union engages in collective bargaining. • These negotiations with employers are aimed at improving working conditions, pay, and benefits. • Union bargaining power refers to the ability of a union to win an agreement with greater wages and benefits for its members. • The primary weapon providing bargaining power to unions is the strike, or work stoppage.

15. Labor Unions PERCENTAGE OF WORKERS BELONGING TO A UNION BY MAJOR INDUSTRY INDUSTRY PERCENT Private wage and salary workers 9.0 Agriculture 1.6 Mining 12.3 Construction 18.4 Manufacturing 14.6 Transportation and public utilities 23.5 Wholesale and retail trade 4.7 Finance, insurance, and real estate 2.1 Services 5.9 Government workers 37.5

16. Labor Unions PERCENTAGE OF WORKERS BELONGING TO A UNION BY OCCUPATION OCCUPATION PERCENT Managerial and professional speciality 12.8 Technical, sales, and administrative support 8.9 Service occupations 13.3 Precision production, craft, and repair 21.3 Operators, fabricators, and laborers 19.9 Farming, forestry, and fishing 4.6

17. Labor Unions • Another union weapon is the boycott, which is a campaign to persuade union members and the public to refrain from purchasing the output of a firm with which the union has a disagreement. • Higher pay means fewer jobs offered by unionized employers. • This increases the supply of labor to similar jobs at non-union employers, and drives down nonunion wages.

18. Human Capital and Signaling • Human capital is the knowledge, skills, and other productivity enhancing attributes embodied within individual workers. • Building human capital involves out of pocket explicit cost, as well as opportunity cost of forgone earnings. • The returns to the investment in a college diploma have increased over the past twenty years.

19. Human Capital and Signaling • The signaling hypothesis provides an alternative to the human capital explanation for greater earnings by college graduates. • Signaling refers to the assumption that education provides information (signals) to employers about the attributes of job applicants.

20. Discrimination and Earnings • Discrimination occurs when a worker who is productive as other workers doing the same job is paid less because of race, gender, color, religion, or natural origin. • Discrimination is illegal in the United States. • Pre-market discrimination exist when a group experiences systematic discrimination prior to entering the labor market. • When applicants are judged by the average characteristics of their racial or ethnic group, the have experienced statistical discrimination.

21. 23.4INCOME INEQUALITY • Income inequality refers to differences in earnings. • Low wages or lack of a job can create poverty. • Poverty is associated with deprivation, which motivates government transfer programs to the poor. • Transfer programs seek to preserve a minimum standard of living for the poor and are referred to as a safety net. • Most households in poverty are very close to the government set safety net.

22. Occupational Segregation Occupational segregationrefers to the concentration of women workers in certain jobs (e.g., nursing and teaching). (Commonly cited as evidence that women are discriminated against in hiring) Women’s earnings are also affected by discontinuous labor force participation, which occurs when a person leaves and later reenters the labor force.

23. Occupational Segregation MALE-DOMINATED OCCUPATIONS (PERCENTAGE OF WORKERS WHO ARE MALES) Automobile mechanics 98.8 Carpenters 98.3 Firefighters 97.0 Airplane pilots and navigators 96.3 Truck drivers 95.3 Surveyors 92.6 Engineers 90.1

24. Occupational Segregation FEMALE-DOMINATED OCCUPATIONS (PERCENTAGE OF WORKERS WHO ARE FEMALES) Dental hygienists 98.5 Prekindergarten and kindergarten teachers 98.4 Child care workers 97.5 Receptionists 96.7 Cleaners and servants 94.8 Cleaners and servants 94.8 Secretaries 94.6 Bookkeepers and accounting clerks 92.2

25. Occupational Segregation

26. 23.5OTHER INCOMES Economic rent refers to earnings in excess of opportunity costs. The incredible earnings reaped by many celebrities and superstar athletes are an example of economic rent. When demand is high and supply is fixed the result is sky-high earnings.

27. A change in demand would affect rent, but not quantity. Economic Rent Supply by Someone with Unique Talents Dollars • Hourly Earnings • • Economic Rent Opportunity Cost Demand Quantity Supplied Quantity of Labor

28. Interest – Keeping Wealth Productive • Interest is the price paid for the use of money. • Interest is usually expressed in terms of a percentage, the interest rate. • The payment of interest to lenders promotes savings, which is used to pay for investments in physical and human capital, that improve standards of living.

29. Profit – Motivating The Entrepreneur • Profit motivates entrepreneurs, who perform the following functions…. • Combining resources • Innovation • Taking risks • Entrepreneurs face the possibility losses as well as profits.

30. 23.6 EXPLORE & APPLYThe Benefits of Schooling • Balanced against the cost of schooling are the benefits. • The tangible benefits of a College education are the increases in the ability to consume goods and services. • A higher lifetime income. • Greater job security. • Relative safe, pleasant working environment that contributes to better health.

31. Earnings and Education Average yearly Earnings $80,000 $60,000 $40,000 $20,000 $0 Less than 9th grade 9th to 12th grade (no diploma) High school graduate Some college, no degree Bachelor's degree Associate's degree Master's degree Professional degree Doctorate degree

32. To earn more later They sacrifice early Three Age/Earnings Profiles College graduate Real Earnings High school graduate Dropouts Age

33. Earnings by Age Group MEDIAN AGE GROUP HOURLY EARNINGS 16 to 19 years $ 6.75 19 to 24 years 8.32 25 to 34 years 10.82 35 to 44 years 11.98 45 to 54 years 12.18 55 to 64 years 11.21 65 years and over 8.37

34. reservation wage substitution effect income effect compensating wage differentials collective bargaining signaling poverty line occupational segregation economic rent interest rate Terms Along the Way

35. Test Yourself • An individual’s labor supply curve will start at the point called the • backward-bending part. • reservation wage. • amount of non-labor income. • income effect.

36. Test Yourself 2. The job most likely to offer a significant compensating wage differential is • baker. • accountant. • computer repair person. • police officer.

37. Test Yourself 3. Labor unions in the United States represent about __________ percent of workers. • 44. • 33. • 22 • 11

38. Test Yourself 4. A right to work law • has no effect on union bargaining power. • increases union bargaining power. • decreases union bargaining power • has unpredictable effects on union bargaining power.

39. Test Yourself 5. From a signaling point of view, earning a college degree will • have no effect on earnings. • decrease earnings. • increase earnings because college increases human capital. • Increase earnings because a college degree is associated with personal characteristics employers value.

40. Test Yourself 6. For blacks to have lower earnings than whites, • employers must practice wage discrimination. • statistical discrimination cannot be practiced by employers. • pre-market discrimination could be the cause. • blacks must be more productive than whites.

41. The End! Next Chapter 24 “Public Goods, Information, and Regulation"