Labor Markets

• Why do skilled workers earn more than unskilled workers?
• Why do college graduates earn more than high school graduates?
• Why do union workers earn higher wages than nonunion workers?
• Why do men earn more than women?

Skill Differentials

Differences in earnings between workers with varying levels of education and training can be explained with a model of competitive labor markets.

• To keep things simple, assume there are only two types of labor: high skilled and low skilled.

Demand for High Skilled and Low Skilled Labor

High skilled workers can perform a wide variety of tasks that low skilled workers would perform badly or perhaps could not even perform at all.

• At any given level of employment, firms are willing to pay a higher wage for high skilled labor.

Supply of High Skilled and Low Skilled Labor

• Skills are costly to acquire.
• A worker usually pays the cost of acquiring the skill before benefiting from a higher wage.
• The acquisition of a skill is therefore an investment.
• Human capital is a person's accumulated skill and knowledge.

Opportunity Cost of Acquiring A Skill

• The opportunity cost of acquiring a skill includes:
  • actual expenditures on things such as tuition and books
  • lost or reduced earnings while the skill is being acquired
• On-the-job trainees are usually paid a lower wage during their training.

Supply Curves

• The position of the supply curve of high skilled workers reflects the cost of acquiring the skill.
• The high skilled worker's supply curve lies above the low skilled worker's supply curves.

Wage Rates

• Equilibrium in both markets occurs where the supply and demand curves for the specific type of labor intersect.

The Causes of Wage Differentials

• The wage of high skilled labor is higher than that of low skilled labor for two reasons:
  • High skilled labor has a higher marginal revenue product than low skilled labor
  • At a given wage rate the supply of high skilled labor is less than the supply of low skilled labor

• There are two important causes of differences in earnings:
  • Education
  • Age and experience

Estimates of the rate of return on a college education (taking all opportunity costs into account) are between 5 and 10 percent per year.

Union - Nonunion
Wage Differentials

• Wage differentials can be caused by labor market monopolies, mainly labor unions.

A labor union is an organized group of workers whose purpose is to increase wages and influence other job conditions for its members.

The Goal of a Labor Union

• A labor union seeks to restrict competition and, as a result, increase the price at which its members sell their labor.

Types of Labor Unions

A craft union is a group of workers who have a similar range of skills but work for many different firms in many different industries and regions.

• An industrial union is a group of workers who have a variety of skills and job types but work for the same firm or industry.

Examples of Unions

• Craft unions include the carpenters' union and the International Brotherhood of Electrical Workers.
• Industrial unions include the United Auto Workers and the Steelworkers Union.
• Most unions are members of the AFL-CIO.

Sizes of Unions

• Unions vary enormously in size.
• Craft unions are the smallest, and industrial unions are the largest.
• In the 1950s, 35 percent of the work force belonged to unions. Only 12 percent are union members today.

Union Organization

• The local is the main subunit of a union.
• In craft unions, the local is based on a geographic area.
• In industrial unions, the plant or firm is the basis for the local.

Types of Union Organizations

• An open shop allows workers to be employed without joining the union.
• A closed shop means all workers must belong to the union.

A union shop allows a firm to hire nonunion workers. However, these workers must join the union after a brief period of employment.

Unions and
Right-to-Work Laws

• A right-to-work law allows an individual to work at any firm without joining a union.
• Twenty states have passed right-to-work laws. In those states, the union shop is also outlawed.

Collective Bargaining

• Unions negotiate with employers or their representatives in a process called collective bargaining.
• There are two weapons available to the union and the employer:
  • A strike
  • A lockout

Strikes, Lockouts, and Binding Arbitration

• A strike is a group decision to refuse to work under the prevailing conditions.
• A lockout is a firm's refusal to operate its plant and employ its workers.
• Binding arbitration uses a third party to determine wages and other employment conditions.

Professional Associations

• A professional association is an organized group of professional workers such as lawyers, dentists, or physicians.
• Professional associations control entry into the profession and license practitioners.
• Technically, a professional association is not a labor union.

• A union has three broad objectives:
  • To increase compensation
  • To improve working conditions
  • To expand job opportunities
• Each objective includes more detailed goals.
  • Increasing compensation may take the form of higher wages, fringe benefits, pensions, and so on.

Union's Constraints

• A union's ability to pursue its objectives is restricted by two sets of constraints:
  • Supply: how well can the union restrict nonunion workers from offering their labor in the same market
  • Demand: the union cannot force firms to hire more than the profit-maximizing quantity of labor.

Unions in a Competitive Labor Market

In a competitive labor market, a union tries to increase wages and other compensation, and to limit employment reductions by increasing demand for the labor supplied by its members.

Impact of a Union on a Competitive Labor Market

• The union can push up wages, but only by restricting the supply of labor.

The total wage bill (wage rate times employment) will rise, remain the same, or fall depending on the elasticity of demand for labor.

• Therefore, they also try to increase the demand for labor.

How Unions Try to Change the Demand for Labor

• Unions try to make the demand curve for labor inelastic using some of the following methods:
  • Encouraging import restrictions
  • Supporting minimum wage laws
  • Supporting immigration restrictions
  • Increasing demand for the good
  • Increase the marginal product of union members

Examples: Minimum Wages and Import Restrictions

Unions generally support increases in the minimum wage to increase the cost of employing low skilled labor. This shifts demand toward high skilled union labor.

• The UAW always supports restrictions on the quantities of foreign cars that can be imported into the U.S.

• A monopsony is a market structure in which a single buyer purchases the entire quantity supplied in the market.
• The best example is a small town in which a single company is the sole employer - a monopsony in the local labor market.

How a Labor Market Monopsony Firm Behaves

• The marginal revenue product of labor curve is still the demand curve.
• The firm recognizes that it must pay a higher wage to hire more labor; it can reduce the wage rate by hiring less labor.
• The firm calculates the marginal cost of labor and uses it to make hiring decisions.

Equilibrium for a Monopsony

The monopsony chooses the quantity of labor that makes the marginal cost of labor equal to the marginal revenue product of labor.

• This quantity will be less than the competitive quantity.
• The firm pays a wage rate based on the labor supply curve.

• Low-cost transportation has eliminated most pure monopsonies.

However, some firms still have a monopsony tendency because they face an upward-sloping labor supply curve. This often occurs in isolated communities.

• There is usually a union in these situations.

Monopsony and Unions

• A union tries to behave like a monopoly supplier of labor.
• A monopsony firm tries to behave like the sole buyer of labor.
• If a monopoly union faces a monopsony buyer of labor, the situation is one of bilateral monopoly.

Bilateral Monopoly

• In bilateral monopoly, the wage rate is determined by bargaining between the two sides.
• The monopsony wants to set a wage rate from the labor supply curve.
• The union wants to set a wage rate from the marginal revenue product curve.

Outcome of Bilateral Monopoly Bargaining

The actual outcome depends on the costs that each party can inflict on the other as a result of a failure to reach an agreement.

• When a strike or lockout occurs, it is usually because one side has incorrect information about the resolve of the other side.

Monopsony and the Minimum Wage

• A minimum wage that exceeds the equilibrium wage in a competitive labor market decreases employment.
• A minimum wage in a monopsony labor market can increase both the wage rate and employment.
• The minimum wage makes labor supply perfectly elastic up to the competitive equilibrium.

Union-Nonunion
Wage Differentials

• Union wage rates are, on average, 30% higher than nonunion wage rates.
• In some industries this wage differential reflects greater skill levels of union members.
• Correcting for skill levels, the differential is between 10% and 25%.

Wage Differentials Between Sexes and Races

• Let's see how we can use economic analysis to address a controversial and emotionally charged issue.

In 1993, the wages of black men were 74% of white men; white women's wages were 70%; and Hispanic women earned 59% of white men's wages.

Why Are There
Wage Differentials?

• There are four possible explanations for these earnings differentials:
  • Job types
  • Discrimination
  • Differences in human capital
  • Differences in degree of specialization

Job Types

Some of the difference in men's and women's wages arises from the fact that men and women do different jobs and, for the most part, men's jobs are better paid than women's jobs.

• This does not explain all of the wage differentials.

Discrimination

• Suppose there are two groups of investment advisors who are identical in their skills. Therefore, their MRPs are identical.
• One group consists solely of black females, the other of white males.
• If there is discrimination, customers will place different values on the output of each group.

• Economists disagree.
• Customers who buy from the white men are paying a higher price for the same service.

This price differential limits discrimination since consumers who do not discriminate will flock to the group of black women who charge the lower price.

Competition and Discrimination

• Suppose a firm's customers never meet its workers.
• A firm that discriminates will have higher costs and lower profits.
• Competition will often force firms like this to either exit from the market or stop discriminating.

Human Capital Differentials

• Wages are compensation in part for time spent on the job and in part for the cost incurred in acquiring human capital.
• Only recently have years of schooling been roughly equalized among the races and sexes.

Work Experience and
Job Interruptions

• Years of work experience and job interruptions are interrelated.
• For people of the same age and schooling, fewer job interruptions usually means more years of work experience.
• Interruptions to a career reduce the effectiveness of job experience.

Job Interruptions

• Job interruptions are more serious for women than for men.
• The main source of these interruptions is bearing and rearing children.

While this factor is historically important in explaining wage differentials, maternity leave and day care are slowly eliminating it.

Degrees of Specialization

• People must choose the amount of time they spend on market activities (labor) and nonmarket activities.

Household production, the main source of nonmarket activities, creates goods and services to be consumed within the household rather than to be supplied to the market.

Specialization Within
the Household

• People can gain from specializing and trading their output with each other.
• This applies to household production as well as market activities.
• The degree of specialization will depend on wage rates, among other things.

Tests of the Degree
of Specialization

Economists have tried to look at data to determine whether the degree of specialization can account for earnings differentials between the sexes.

• It appears that the degree of specialization accounts for between 14 and 19 percent of wage differentials.

Comparable-Worth Laws

• The Equal Pay Act (1963) and Civil Rights Act (1964) require equal pay for equal work.

Some people believe that comparable jobs - those requiring the same levels of skills and responsibilities - should be paid the same wage.

• This is called comparable worth.

What Comparable
Worth Ignores

Comparable worth advocates focus exclusively on the supply side of the labor market - the skills and training required by different occupations.

• This ignores the demand side which is just as important in determining wages.