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Earnings

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This chapter discusses factors that influence earnings variations and discrimination in the labor market. It explains that earnings are determined by supply and demand for different jobs as well as individual characteristics like education, ability, and discrimination. While competitive markets tend to reduce discrimination, it can persist if customers prefer discriminatory businesses or governments mandate discriminatory policies. The chapter also examines methods for measuring discrimination while controlling for other wage-influencing variables.

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CHAPTER 19 EARNINGS AND DISCRIMINATION19Earnings and Discrimination
CHAPTER 19 EARNINGS AND DISCRIMINATIONEarnings VariationsDifferences in Earnings in the United States TodayThe typical physician earns about $200,000 a year.The typical police officer earns about $50,000 a year.The typical farm worker earns about $20,000 a year.
CHAPTER 19 EARNINGS AND DISCRIMINATIONEarnings and ProductivityWages are governed by labor supply and labor demand.Labor demand reflects the marginal productivity of labor.Labor supply reflects the marginal opportunity cost of work.
CHAPTER 19 EARNINGS AND DISCRIMINATIONEarningsIn equilibrium, each worker is paid a wage equal to the value of his or her marginal product (or, contribution to the economy’s production of goods and services).This wage is also equal to the marginal cost of working.We saw all this in Chapter 18.
CHAPTER 19 EARNINGS AND DISCRIMINATIONSupply(Marginal Opportunity Cost of Labor)Equilibriumwage, WDemand(Value of the Marginal Product of Labor)Equilibriumemployment, LCh. 18 Figure 4 Equilibrium in a Labor MarketWage(price oflabor)Quantity of0Labor
CHAPTER 19 EARNINGS AND DISCRIMINATIONEarnings VariationsBut all this still does not explain why earnings vary from profession to profession and from person to person.
CHAPTER 19 EARNINGS AND DISCRIMINATIONSOME DETERMINANTS OF EQUILIBRIUM WAGESCompensating differentialsHuman capitalAbility, effort, and chanceSignalingThe superstar phenomenon
CHAPTER 19 EARNINGS AND DISCRIMINATIONCompensating DifferentialsCompensating differential refers to a difference in wages that offset the different non-monetary characteristicsof different jobs.Coal miners are paid more than others with similar levels of education.Night-shift workers are paid more than day-shift workers.Professors are paid less than lawyers and doctors.
CHAPTER 19 EARNINGS AND DISCRIMINATIONHuman CapitalHuman capital is the accumulation of investments in people. It includeseducation, and on-the-job training. Higher human capital leads to higher productivity and, therefore, a higher wage.
CHAPTER 19 EARNINGS AND DISCRIMINATIONHuman CapitalEducation represents an expenditure of resources at one point in time to raise productivity in the future.By the year 2003, a man with a college degree earned 82 percent more than a man without one. Women showed a 71 percent increase in earnings due to a college degree.
CHAPTER 19 EARNINGS AND DISCRIMINATIONTable 1 Average Annual Earnings by Educational AttainmentThe advantage of college education is large and increasing.
CHAPTER 19 EARNINGS AND DISCRIMINATIONThe Increasing College Premium Why has the gap in earnings between skilled and unskilled workers risen in recent years? Here are two hypotheses:Globalization provides more opportunities for our skilled labor and reduces the need for our unskilled labor.Technological progress has increased the need for skilled labor and reduced the need for unskilled labor.
CHAPTER 19 EARNINGS AND DISCRIMINATIONAbility, Effort, and ChanceHigh natural ability leads to high productivity and a high wage.One’s love of leisure and one’s natural ability determine one’s effort. Effort determines productivity and the wage.These characteristics of a worker are determined by chance.Chance also determines whether one chooses the right career.
CHAPTER 19 EARNINGS AND DISCRIMINATIONThe Benefits of BeautyA 1994 poll was used to rank a set of pictures of people by beautyAfter controlling for education, job experience, profession, and other standard determinants of wages, it was found that people considered more attractive than average earned 5 to 10 percent more than those considered less attractive than average.Why does beauty make a difference?
CHAPTER 19 EARNINGS AND DISCRIMINATIONAn Alternative View of Education: SignalingAccording to another theory, education does not improve productivity. Firms use educational attainment as a way of sorting between high-ability and low-ability workers.It is rational for firms to interpret a college degree as a signal of ability. As a result, the college-educated earn more even though college is a waste of time.
CHAPTER 19 EARNINGS AND DISCRIMINATIONEducation: does it really help?The human capital approach is probably true for those with professional degreesThe signaling approach may be true for liberal arts majors
CHAPTER 19 EARNINGS AND DISCRIMINATIONThe Superstar PhenomenonSuperstars arise in markets that exhibit the following characteristics:Every customer in the market wants to enjoy the good supplied by the best producer.The good is produced with a technology that makes it possible for the best producer to supply every customer at a low cost.In such a market wages vary a great deal more than ability does.
CHAPTER 19 EARNINGS AND DISCRIMINATIONAbove-Equilibrium WagesMinimum-wage lawsMarket power of labor unionsEfficiency wages
CHAPTER 19 EARNINGS AND DISCRIMINATIONAbove-Equilibrium Wages: UnionsA union is a worker association that bargains with employers over wages and working conditions.A union’s final weapon is a strike. A strike refers to the organized withdrawal of labor from a firm by a union.Union workers earn 10 to 20 percent more than similar non-union workers
CHAPTER 19 EARNINGS AND DISCRIMINATIONAbove-Equilibrium Wages: Efficiency Wages The theory of efficiency wages holds that a firm can find it profitable to pay high wages because doing so increases the productivity of its workers. High wages may: reduce worker turnover. increase worker effort. raise the quality of workers that apply for jobs at the firm.
CHAPTER 19 EARNINGS AND DISCRIMINATIONTHE ECONOMICS OF DISCRIMINATIONWages are also affected by discrimination.Discrimination occurs when the marketplace offers different opportunities to similar individuals who differ only by race, ethnic group, sex, age, or other personal characteristics.
CHAPTER 19 EARNINGS AND DISCRIMINATIONTHE ECONOMICS OF DISCRIMINATIONAlthough discrimination is an emotionally charged topic, economists try to study the topic objectively in order to separate myth from reality.
CHAPTER 19 EARNINGS AND DISCRIMINATIONMeasuring Labor-Market DiscriminationDiscrimination is often measured by looking at the average wages of different groups.
CHAPTER 19 EARNINGS AND DISCRIMINATIONMeasuring Labor-Market DiscriminationEven in a labor market free of discrimination, different people have different wages.
CHAPTER 19 EARNINGS AND DISCRIMINATIONMeasuring Labor-Market DiscriminationPeople differ in the amount of human capital they have and in the kinds of work they are willing and able to do.
CHAPTER 19 EARNINGS AND DISCRIMINATIONMeasuring Labor-Market DiscriminationSimply observing differences in wages among broad groups—white and black, men and women—says little about the prevalence of discrimination.
CHAPTER 19 EARNINGS AND DISCRIMINATIONTable 2 Median Annual Earnings by Race and Sex
CHAPTER 19 EARNINGS AND DISCRIMINATIONMeasuring Labor-Market DiscriminationBecause the differences in average wages among groups in part reflect differences in human capital and job characteristics, they do not by themselves say anything about how much discrimination there is in the labor market.
CHAPTER 19 EARNINGS AND DISCRIMINATIONDiscrimination by EmployersThe fact that discrimination is hard to measure does not mean that it does not happen.Firms may discriminate in their hiring. However, Firms that do not discriminate will have lower labor costs when they hire the employees discriminated against.
CHAPTER 19 EARNINGS AND DISCRIMINATIONDiscrimination by EmployersNondiscriminatory firms will tend to out-compete and replace firms that discriminate.
CHAPTER 19 EARNINGS AND DISCRIMINATIONDiscrimination by EmployersCompetitive markets tend to limit the impact of discrimination on wages.Firms that do not discriminate will be more profitable than those firms that do discriminate.
CHAPTER 19 EARNINGS AND DISCRIMINATIONDiscrimination by Customers and GovernmentsAlthough the profit motive is a strong force acting to eliminate discriminatory wage differentials, there are limits to its corrective abilities.Customer preferencesGovernment policies
CHAPTER 19 EARNINGS AND DISCRIMINATIONDiscrimination by CustomersIf customers have discriminatory preferences, firms in a competitive market may discriminate for profitability reasons. This will happen when customers are willing to pay to maintain the discriminatory practice.
CHAPTER 19 EARNINGS AND DISCRIMINATIONDiscrimination in sportsAccording to a 1988 study, black basketball players earned 20 percent less than white players of comparable ability.A possible explanation is discrimination by fans.Late 1960s data showed that black baseball players earned less than white players of similar abilityA 1990 study found that baseball cards for black hitters (pitchers) sold for 10 percent (13 percent) less than cards for comparable white hitters (pitchers)
CHAPTER 19 EARNINGS AND DISCRIMINATIONDiscrimination by GovernmentsWhen the government mandates discriminatory practices or requires firms to discriminate, this may lead to discriminatory wage differentials.Streetcars in the southern states in the early 20th century practiced racial discrimination in seating under the pressure of government laws. These laws were resisted by the firms because of adverse effects on profitability.
CHAPTER 19 EARNINGS AND DISCRIMINATIONSummaryWorkers earn different wages for many reasons.To some extent, wage differentials compensate workers for job attributes.Workers with more human capital get paid more than workers with less human capital.
CHAPTER 19 EARNINGS AND DISCRIMINATIONSummaryThe return to accumulating human capital is high and has increased over the past decade.There is much variation in earnings that cannot be explained by things economists can measure.
CHAPTER 19 EARNINGS AND DISCRIMINATIONSummaryThe unexplained variation in earnings is largely attributable to natural ability, effort, and chance.Some economists have suggested that more-educated workers earn higher wages because workers with high natural ability use education as a way to signal their high ability to employers.
CHAPTER 19 EARNINGS AND DISCRIMINATIONSummaryWages are sometimes pushed above the equilibrium level because of minimum-wage laws, unions, and efficiency wages.Some differences in earnings are attributable to discrimination on the basis of race, sex, or other factors.When measuring the amount of discrimination, one must correct for differences in human capital and job characteristics.

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  • 1. CHAPTER 19 EARNINGS AND DISCRIMINATION19Earnings and Discrimination
  • 2. CHAPTER 19 EARNINGS AND DISCRIMINATIONEarnings VariationsDifferences in Earnings in the United States TodayThe typical physician earns about $200,000 a year.The typical police officer earns about $50,000 a year.The typical farm worker earns about $20,000 a year.
  • 3. CHAPTER 19 EARNINGS AND DISCRIMINATIONEarnings and ProductivityWages are governed by labor supply and labor demand.Labor demand reflects the marginal productivity of labor.Labor supply reflects the marginal opportunity cost of work.
  • 4. CHAPTER 19 EARNINGS AND DISCRIMINATIONEarningsIn equilibrium, each worker is paid a wage equal to the value of his or her marginal product (or, contribution to the economy’s production of goods and services).This wage is also equal to the marginal cost of working.We saw all this in Chapter 18.
  • 5. CHAPTER 19 EARNINGS AND DISCRIMINATIONSupply(Marginal Opportunity Cost of Labor)Equilibriumwage, WDemand(Value of the Marginal Product of Labor)Equilibriumemployment, LCh. 18 Figure 4 Equilibrium in a Labor MarketWage(price oflabor)Quantity of0Labor
  • 6. CHAPTER 19 EARNINGS AND DISCRIMINATIONEarnings VariationsBut all this still does not explain why earnings vary from profession to profession and from person to person.
  • 7. CHAPTER 19 EARNINGS AND DISCRIMINATIONSOME DETERMINANTS OF EQUILIBRIUM WAGESCompensating differentialsHuman capitalAbility, effort, and chanceSignalingThe superstar phenomenon
  • 8. CHAPTER 19 EARNINGS AND DISCRIMINATIONCompensating DifferentialsCompensating differential refers to a difference in wages that offset the different non-monetary characteristicsof different jobs.Coal miners are paid more than others with similar levels of education.Night-shift workers are paid more than day-shift workers.Professors are paid less than lawyers and doctors.
  • 9. CHAPTER 19 EARNINGS AND DISCRIMINATIONHuman CapitalHuman capital is the accumulation of investments in people. It includeseducation, and on-the-job training. Higher human capital leads to higher productivity and, therefore, a higher wage.
  • 10. CHAPTER 19 EARNINGS AND DISCRIMINATIONHuman CapitalEducation represents an expenditure of resources at one point in time to raise productivity in the future.By the year 2003, a man with a college degree earned 82 percent more than a man without one. Women showed a 71 percent increase in earnings due to a college degree.
  • 11. CHAPTER 19 EARNINGS AND DISCRIMINATIONTable 1 Average Annual Earnings by Educational AttainmentThe advantage of college education is large and increasing.
  • 12. CHAPTER 19 EARNINGS AND DISCRIMINATIONThe Increasing College Premium Why has the gap in earnings between skilled and unskilled workers risen in recent years? Here are two hypotheses:Globalization provides more opportunities for our skilled labor and reduces the need for our unskilled labor.Technological progress has increased the need for skilled labor and reduced the need for unskilled labor.
  • 13. CHAPTER 19 EARNINGS AND DISCRIMINATIONAbility, Effort, and ChanceHigh natural ability leads to high productivity and a high wage.One’s love of leisure and one’s natural ability determine one’s effort. Effort determines productivity and the wage.These characteristics of a worker are determined by chance.Chance also determines whether one chooses the right career.
  • 14. CHAPTER 19 EARNINGS AND DISCRIMINATIONThe Benefits of BeautyA 1994 poll was used to rank a set of pictures of people by beautyAfter controlling for education, job experience, profession, and other standard determinants of wages, it was found that people considered more attractive than average earned 5 to 10 percent more than those considered less attractive than average.Why does beauty make a difference?
  • 15. CHAPTER 19 EARNINGS AND DISCRIMINATIONAn Alternative View of Education: SignalingAccording to another theory, education does not improve productivity. Firms use educational attainment as a way of sorting between high-ability and low-ability workers.It is rational for firms to interpret a college degree as a signal of ability. As a result, the college-educated earn more even though college is a waste of time.
  • 16. CHAPTER 19 EARNINGS AND DISCRIMINATIONEducation: does it really help?The human capital approach is probably true for those with professional degreesThe signaling approach may be true for liberal arts majors
  • 17. CHAPTER 19 EARNINGS AND DISCRIMINATIONThe Superstar PhenomenonSuperstars arise in markets that exhibit the following characteristics:Every customer in the market wants to enjoy the good supplied by the best producer.The good is produced with a technology that makes it possible for the best producer to supply every customer at a low cost.In such a market wages vary a great deal more than ability does.
  • 18. CHAPTER 19 EARNINGS AND DISCRIMINATIONAbove-Equilibrium WagesMinimum-wage lawsMarket power of labor unionsEfficiency wages
  • 19. CHAPTER 19 EARNINGS AND DISCRIMINATIONAbove-Equilibrium Wages: UnionsA union is a worker association that bargains with employers over wages and working conditions.A union’s final weapon is a strike. A strike refers to the organized withdrawal of labor from a firm by a union.Union workers earn 10 to 20 percent more than similar non-union workers
  • 20. CHAPTER 19 EARNINGS AND DISCRIMINATIONAbove-Equilibrium Wages: Efficiency Wages The theory of efficiency wages holds that a firm can find it profitable to pay high wages because doing so increases the productivity of its workers. High wages may: reduce worker turnover. increase worker effort. raise the quality of workers that apply for jobs at the firm.
  • 21. CHAPTER 19 EARNINGS AND DISCRIMINATIONTHE ECONOMICS OF DISCRIMINATIONWages are also affected by discrimination.Discrimination occurs when the marketplace offers different opportunities to similar individuals who differ only by race, ethnic group, sex, age, or other personal characteristics.
  • 22. CHAPTER 19 EARNINGS AND DISCRIMINATIONTHE ECONOMICS OF DISCRIMINATIONAlthough discrimination is an emotionally charged topic, economists try to study the topic objectively in order to separate myth from reality.
  • 23. CHAPTER 19 EARNINGS AND DISCRIMINATIONMeasuring Labor-Market DiscriminationDiscrimination is often measured by looking at the average wages of different groups.
  • 24. CHAPTER 19 EARNINGS AND DISCRIMINATIONMeasuring Labor-Market DiscriminationEven in a labor market free of discrimination, different people have different wages.
  • 25. CHAPTER 19 EARNINGS AND DISCRIMINATIONMeasuring Labor-Market DiscriminationPeople differ in the amount of human capital they have and in the kinds of work they are willing and able to do.
  • 26. CHAPTER 19 EARNINGS AND DISCRIMINATIONMeasuring Labor-Market DiscriminationSimply observing differences in wages among broad groups—white and black, men and women—says little about the prevalence of discrimination.
  • 27. CHAPTER 19 EARNINGS AND DISCRIMINATIONTable 2 Median Annual Earnings by Race and Sex
  • 28. CHAPTER 19 EARNINGS AND DISCRIMINATIONMeasuring Labor-Market DiscriminationBecause the differences in average wages among groups in part reflect differences in human capital and job characteristics, they do not by themselves say anything about how much discrimination there is in the labor market.
  • 29. CHAPTER 19 EARNINGS AND DISCRIMINATIONDiscrimination by EmployersThe fact that discrimination is hard to measure does not mean that it does not happen.Firms may discriminate in their hiring. However, Firms that do not discriminate will have lower labor costs when they hire the employees discriminated against.
  • 30. CHAPTER 19 EARNINGS AND DISCRIMINATIONDiscrimination by EmployersNondiscriminatory firms will tend to out-compete and replace firms that discriminate.
  • 31. CHAPTER 19 EARNINGS AND DISCRIMINATIONDiscrimination by EmployersCompetitive markets tend to limit the impact of discrimination on wages.Firms that do not discriminate will be more profitable than those firms that do discriminate.
  • 32. CHAPTER 19 EARNINGS AND DISCRIMINATIONDiscrimination by Customers and GovernmentsAlthough the profit motive is a strong force acting to eliminate discriminatory wage differentials, there are limits to its corrective abilities.Customer preferencesGovernment policies
  • 33. CHAPTER 19 EARNINGS AND DISCRIMINATIONDiscrimination by CustomersIf customers have discriminatory preferences, firms in a competitive market may discriminate for profitability reasons. This will happen when customers are willing to pay to maintain the discriminatory practice.
  • 34. CHAPTER 19 EARNINGS AND DISCRIMINATIONDiscrimination in sportsAccording to a 1988 study, black basketball players earned 20 percent less than white players of comparable ability.A possible explanation is discrimination by fans.Late 1960s data showed that black baseball players earned less than white players of similar abilityA 1990 study found that baseball cards for black hitters (pitchers) sold for 10 percent (13 percent) less than cards for comparable white hitters (pitchers)
  • 35. CHAPTER 19 EARNINGS AND DISCRIMINATIONDiscrimination by GovernmentsWhen the government mandates discriminatory practices or requires firms to discriminate, this may lead to discriminatory wage differentials.Streetcars in the southern states in the early 20th century practiced racial discrimination in seating under the pressure of government laws. These laws were resisted by the firms because of adverse effects on profitability.
  • 36. CHAPTER 19 EARNINGS AND DISCRIMINATIONSummaryWorkers earn different wages for many reasons.To some extent, wage differentials compensate workers for job attributes.Workers with more human capital get paid more than workers with less human capital.
  • 37. CHAPTER 19 EARNINGS AND DISCRIMINATIONSummaryThe return to accumulating human capital is high and has increased over the past decade.There is much variation in earnings that cannot be explained by things economists can measure.
  • 38. CHAPTER 19 EARNINGS AND DISCRIMINATIONSummaryThe unexplained variation in earnings is largely attributable to natural ability, effort, and chance.Some economists have suggested that more-educated workers earn higher wages because workers with high natural ability use education as a way to signal their high ability to employers.
  • 39. CHAPTER 19 EARNINGS AND DISCRIMINATIONSummaryWages are sometimes pushed above the equilibrium level because of minimum-wage laws, unions, and efficiency wages.Some differences in earnings are attributable to discrimination on the basis of race, sex, or other factors.When measuring the amount of discrimination, one must correct for differences in human capital and job characteristics.
  • 40. CHAPTER 19 EARNINGS AND DISCRIMINATIONSummaryCompetitive markets tend to limit the impact of discrimination on wages.Discrimination can persist in competitive markets if customers arewilling to pay more to discriminatory firms,or if the government passes laws requiring firms to discriminate.