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Wage Determination

26. Wage Determination. Chapter Objectives. Why Labor Productivity and Real Hourly Compensation Track So Closely Over Time How Wage Rates and Employment Levels are Determined in Competitive Labor Markets How Monopsony Can Reduce Wages Below Competitive Levels

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Wage Determination

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  1. 26 Wage Determination

  2. Chapter Objectives • Why Labor Productivity and Real Hourly Compensation Track So Closely Over Time • How Wage Rates and Employment Levels are Determined in Competitive Labor Markets • How Monopsony Can Reduce Wages Below Competitive Levels • How Unions Can Increase Wage Rates • The Major Causes of Wage Differentials • The Types, Benefits, and Costs of “Pay-for-Performance” Plans

  3. Labor Wages and Earnings • Wage Rate – price paid per unit of labor services (hour of work) • Nominal Wage – amount of money received per hour, day, or year • Real Wage – purchasing power of nominal wage

  4. General Level of Wages • Wages differ among regions, occupations, and individuals • Ex. Wages higher in U.S. than China or India • Role of Productivity • Plentiful Capital – access to machines and buildings • Access to Abundant Natural Resources • Advanced Technology • Labor Quality –health, education, training of workers • Other Factors – management efficiency, sociopolitical environment, size of market, trade agreements

  5. GLOBAL PERSPECTIVE Labor Wages and Earnings Hourly Wages of Production Workers Selected Nations Hourly Pay in U.S. Dollars, 2004 0 5 10 15 20 25 30 35 33.75 Denmark Germany Switzerland Sweden United Kingdom France United States Australia Japan Canada Italy Korea Taiwan Mexico 32.53 30.26 28.42 24.71 23.89 23.17 23.09 21.90 21.42 20.48 11.52 5.97 2.50 Source: U.S. Bureau of Labor Statistics, 2006

  6. Real Wages and Productivity • Close long-run relationship between output per hour and real hourly compensation • See p.507 Figure 26.1 • Secular Growth of Real Wages: over the decades labor demand has increased more rapidly than labor supply, resulting in long-run increase in wages and employment

  7. Real Wages and Productivity • Secular Growth of Real Wages • Long Run Trend of Real Wages in the U.S. S2020 S2000 S1950 S1900 Real Wage Rate (Dollars) D2020 D2000 D1950 D1900 Quantity of Labor

  8. Purely Competitive Labor Market • Numerous firms competing in hiring a specific type of labor • Many qualified workers of identical skill levels supplying labor • Firms and workers are wage takers, neither controls market wage

  9. Purely Competitive Labor Market • Market Demand for Labor – horizontal summation of individual labor demand (MRP) curves • Market Supply for Labor – assumes no unions, competition, reflects law of supply • Labor Market Equilibrium – curve intersection • MRP = MRC Rule Graphically…

  10. G 26.1 Purely Competitive Labor Market Labor Market Individual Firm a S b e s=MRC Wage Rate (Dollars) Wage Rate (Dollars) ($10) WC ($10) WC D=MRP (∑ mrps) d=mrp c 0 0 qC QC (5) (1000) Quantity of Labor Quantity of Labor

  11. O 26.1 G 26.2 Monopsony Model • Monopsony • Upward-Sloping Labor Supply to Firm • MRC Higher Than the Wage Rate • Equilibrium Wage and Employment Graphically…

  12. Monopsony Model • Monopsony – market in which single employer of labor has substantial hiring power • Characteristics: • Single buyer of type of labor • Labor is relatively immobile • Firm is a wage maker, wage rate it pays varies directly with number of workers it employs • Various degrees of power

  13. Monopsony Model • Upward-sloping labor supply to firm • MRC is higher than the wage rate • To maximize profit, quantity at MRP=MRC, pay workers wage rate at supply curve • See Figure 26.4 • Monopsonist hires a smaller number of workers and pays a lower wage rate than pure competitor • Examples?

  14. W 26.1 Monopsony Model Monopsonistic Labor Market MRC S b a Wage Rate (Dollars) Wc Wm c MRP 0 Qc Qm Quantity of Labor Examples of Monopsony Power

  15. Three Union Models • In some labor markets, workers will sell their labor services collectively through unions • Many goals, most important is to raise wages

  16. Three Union Models • Demand Enhancement Model • Increase Product Demand • Increase Productivity • Alter the Price of Other Inputs S Increase In Demand Wu Wage Rate (Dollars) Wc D2 D1 Qu Qc Quantity of Labor

  17. Three Union Models • Exclusive or Craft Union Model – reduces labor supply • Restricted Immigration • Reduced Child Labor • Encouraged Compulsory Retirement • Shorter Hour Workweek • Exclusive Unionism • Occupational Licensing Graphically…

  18. Three Union Models • Exclusive or Craft Union Model S2 S1 Wage Rate (Dollars) Decrease In Supply Wu Wc D Qu Qc Quantity of Labor

  19. Three Union Models • Inclusive or Industrial Union Model • Inclusive Unionism S b a Wage Rate (Dollars) Wu e Wc D Qu Qe Qc Quantity of Labor

  20. Three Union Models • Wage Increases and Unemployment • Average 15% Higher Wages • Reduced Employment Levels Corrected by: • Growth • Elasticity

  21. Bilateral Monopoly Model • Single seller and a single buyer • Ex. Union in labor market that is monopsonistic • Ex. Steel, auto industry, professional sports

  22. Bilateral Monopoly • Indeterminate Outcome • Desirability of Bilateral Monopoly S MRC Wage Rate (Dollars) Wu a Wc Wm D=MRP Qu=Qm Qc Quantity of Labor

  23. Minimum Wage • Case Against the Minimum Wage – firms hire fewer workers, harms businesses • Case For the Minimum Wage – may increase productivity, reduce labor turnover • State and Locally Set Rates • Evidence and Conclusions – no clear answer, overall effect uncertain

  24. Annual Average Wages Occupation Wage Differentials Average Annual Wages in Selected Occupations, 2005 $177,690 135,040 97,350 96,620 95,570 79,230 60,620 56,880 47,270 45,630 37,750 24,700 23,170 22,420 21,100 15,500 Surgeons Aircraft Pilots Petroleum Engineers Financial Managers Law Professors Chemical Engineers Dental Hygienists Registered Nurses Police Officers Electricians Travel Agents Barbers Retail Salespersons Recreation Workers Teacher Aides Fast Food Cooks Source: Bureau of Labor Statistics, 2006

  25. O 26.2 Wage Differentials • Wage rates and salaries vary among and within occupations • Marginal Revenue Productivity – higher for higher-paid workers

  26. Wage Differentials • Noncompeting Groups -occupations for which members of a particular group qualify • Ability (Ex. Surgeon, athlete) • Education and Training • Human Capital – personal knowledge, skills • Compensating Differences – must be paid to compensate for nonmonetary differences in various jobs • Ex. Construction, mining

  27. Wage Differentials Education Levels and Individual Annual Earnings Educational Attainment Professional Degree Annual Earnings (Thousands of Dollars) Bachelor’s Degree Associate’s Degree High School Diploma Age

  28. Wage Differentials • Marginal Revenue • Market Imperfections • Lack of Job Information • Geographic Immobility • Unions and Government Restraints • Discrimination

  29. O 26.3 O 26.4 Pay for Performance • The Principal-Agent Problem Revisited • Incentive Pay Plan – ties worker compensation to output/performance • Piece Rates-based on units • Commissions or Royalties • Bonuses, Stock Options, and Profit Sharing • Efficiency Wages • Negative Side-Effects of Pay for Performance – lack of quality, fraudulent practices, etc.

  30. Are Chief Executive Officers (CEOs) Overpaid? Last Word • Current U.S. CEO Salaries are High Relative to Domestic or Foreign Firms • Several Possible Reasons • Marginal Productivity Impact by Good Decisions • Top Salaries Like “Prize” Goals for all to Have as a Goal Impacting Many Jobs • High Salary Bias by Board Members Due to their Own Previous Performances • Some Argue High Salaries are Unjustified and are Unfair to Stockholders

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