Chapter 17 – Wage Determination
17-1
Chapter 17 – Wage Determination
McConnell Brue Flynn 21e
DISCUSSSION QUESTIONS
1. Explain why the general level of wages is high in the United States and other industrially
advanced countries. What is the single most important factor underlying the long‐run increase in
average real‐wage rates in the United States? LO1
Answer: The general level of wages is higher in the United States and other industrially
2. Why is a firm in a purely competitive labor market a wage taker? What would happen if it
decided to pay less than the going market wage rate? LO2
3. Describe wage determination in a labor market in which workers are unorganized and many
firms actively compete for the services of labor. Show this situation graphically, using W1 to
indicate the equilibrium wage rate and Q1 to show the number of workers hired by the firms as a
group. Show the labor supply curve of the individual firm, and compare it with that of the total
market. Why the differences? In the diagram representing the firm, identify total revenue, total
wage cost, and revenue available for the payment of non-labor resources. LO2
Chapter 17 – Wage Determination
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4. Suppose the formerly competing firms in review question 1 form an employers’ association
that hires labor as a monopsonist would. Describe verbally the effect on wage rates and
employment. Adjust the graph you drew for review question 1, showing the monopsonistic wage
rate and employment level as W2 and Q2, respectively. Using this monopsony model, explain why
hospital administrators sometimes complain about a “shortage” of nurses. How might such a
shortage be corrected? LO3
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5. Assume a monopsonistic employer is paying a wage rate of Wm and hiring Qm workers, as
indicated in Figure 15.8. Now suppose an industrial union is formed that forces the employer to
accept a wage rate of Wc. Explain verbally and graphically why in this instance the higher wage
rate will be accompanied by an increase in the number of workers hired. LO5
6. Have you ever worked for the minimum wage? If so, for how long? Would you favor
increasing the minimum wage by a dollar? By two dollars? By five dollars? Explain your
reasoning. LO6
7. “Many of the lowest‐paid people in society—for example, short‐order cooks— also have
relatively poor working conditions. Hence, the notion of compensating wage differentials is
disproved.” Do you agree? Explain. LO7
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8. What is meant by investment in human capital? Use this concept to explain (a) wage
differentials and (b) the long‐run rise of real wage rates in the United States. LO7
9. What is the principal‐agent problem? Have you ever worked in a setting where this problem
has arisen? If so, do you think increased monitoring would have eliminated the problem? Why
don’t firms simply hire more supervisors to eliminate shirking? LO8
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10. LAST WORD Speculate as to why we see unnecessary occupational licensing only in some
industries but not others. Consider both costs and benefits, who gets them, and how hard it would
be to organize opposition to unnecessary licensing in various industries. LO8
REVIEW QUESTIONS
1. Brenda owns a construction company that employs bricklayers and other skilled tradesmen.
Her firm’s MRP for bricklayers is $22.25 per hour for each of the first seven bricklayers, $18.50
for an eighth brick layer, and $17.75 for a ninth bricklayer. Given that she is a price taker when
hiring bricklayers, how many bricklayers will she hire if the market equilibrium wage for
bricklayers is $18.00 per hour? LO2
a. Zero.
b. Seven.
c. Eight.
d. Nine.
e. More information is required to answer this question.
Answer: d. Nine.
2. Because a perfectly competitive employer’s MRC curve is ______________, it will hire
____________ workers than would a monoposony employer with the same MRP curve. LO3
a. Upsloping; more.
b. Upsloping; fewer.
c. Flat; more.
d. Flat; fewer.
e. Downsloping; more.
f. Downsloping; fewer.
Chapter 17 – Wage Determination
17-6
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consent of McGraw-Hill Education.
Answer: c. flat; more.
The wage that is paid to employers is determined for both perfectly competitive
employers and monopsony employers by the intersection of MRC and MRP. The
difference between the two types of employers is that monoposony employers have
upsloping MRC curves whereas perfectly competitive employers have horizontal MRC
curves.
This difference is due to the fact that perfectly competitive employers are able to hire as
many workers as they please at the market equilibrium wage. By contrast, a monopsony
employer faces the upsloping market supply curve for labor, which implies that the only
way for the monopsony employer to increase the number of workers it employs is by
raising wages.
The fact that it must raise wages to hire additional workers will make it less willing to
hire additional workers than the perfectly competitive firm that can hire as many workers
as it pleases at the fixed market equilibrium wage. This difference in MRCs will cause
the monopsony employer to hire fewer workers than would a purely competitive firm
with the same MRP curve.
3. True or false. When a labor market consists of a single monopsony buyer of labor interacting
with a single monopoly seller of labor (such as a trade union), the resulting quantity of labor that
is hired will always be inefficiently low. LO5
4. The market equilibrium wage is currently $12 per hour among hairdressers. At that wage,
17,323 hairdressers are currently employed in the state. The state legislature then sets a minimum
wage of $11.50 per hour for hairdressers. If there are no changes to either the demand or supply
for hairdressers when that minimum wage is imposed, the number of hairdressers employed in the
state will be: LO6
a. Fewer than 17,323.
b. Still 17,323.
c. More than 17,323.
d. This is a bilateral monopsony so you can’t tell.
Chapter 17 – Wage Determination
17-7
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consent of McGraw-Hill Education.
Answer: b. Still 17,323.
The state’s minimum wage of $11.50 per hour for hairdressers is below the current
market equilibrium wage of $12 per hour. So it will affect neither the behavior of
demanders or suppliers. Thus, the wage will continue to be determined by the intersection
of the demand and supply curves—which implies that the market equilibrium will not
change and that the equilibrium wage and the equilibrium number of hairdressers
employed will stay the same (at 17,323).
Another way to see this is to realize that minimum wages are price floors below which
wages are not allowed to fall. But since the market equilibrium wage is already above the
$11.50 per hour price floor that the state legislature is imposing, it will not be affected.
Thus, the market equilibrium is unchanged and the same number of hairdressers are
employed (17,323).
5. On average, 50-year old workers are paid several times more than workers in their teens and
twenties. Which of the following options is the most likely explanation for that huge difference
in average earnings? LO7
a. Older workers have more human capital and higher MRPs.
b. Employers engage in widespread discrimination against younger workers.
c. Young people lack information about the existence of the high-paying jobs occupied by older
workers.
d. Older workers receive compensating differences because they do jobs that are more risky than
the jobs done by younger workers.
Chapter 17 – Wage Determination
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6. Manny owns a local fast-food franchise. Angel runs it for him. So in this situation, Manny is
the ____________ and Angel is the ________________. LO8
a. Free rider; entrepreneur.
b. Agent; principal.
c. Principal; agent.
d. Producer; consumer.
7. A principal is worried that her agent may not do what she wants. As a solution, she should
consider: LO8
a. Commissions.
b. Bonuses.
c. Profit sharing.
d. All of the above.
Chapter 17 – Wage Determination
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PROBLEMS
1. Workers are compensated by firms with “benefits” in addition to wages and salaries. The most
prominent benefit offered by many firms is health insurance. Suppose that in 2000 workers at one
steel plant were paid $20 per hour and in addition received health benefits at the rate of $4 per
hour. Also suppose that by 2010 workers at that plant were paid $21 per hour but received $9 in
health insurance benefits. LO1
a. By what percentage did total compensation (wages plus benefits) change at this plant from
2000 to 2010? What was the approximate average annual percentage change in total
compensation?
b. By what percentage did wages change at this plant from 2000 to 2010? What was the
approximate average annual percentage change in wages?
c. If workers value a dollar of health benefits as much as they value a dollar of wages, by what
total percentage will they feel that their incomes have risen over this time period? What if they
only consider wages when calculating their incomes?
d. Is it possible for workers to feel as though their wages are stagnating even if total
compensation is rising?
Feedback:
Part c:
Chapter 17 – Wage Determination
2. Complete the following labor supply table for a firm hiring labor competitively:
LO2
a. Show graphically the labor supply and marginal resource (labor) cost curves for this firm. Are
the curves the same or different? If they are different, which one is higher?
b. Plot the labor demand data of review question 2 in Chapter 16 on the graph used in part a
above. What are the equilibrium wage rate and level of employment?
Chapter 17 – Wage Determination
17-11
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consent of McGraw-Hill Education.
(b)
Chapter 17 – Wage Determination
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Feedback:
(a) The labor supply curve and MRC curve coincide as a single horizontal line at the
market wage rate of $14. The firm can employ as much labor as it wants, each unit
Chapter 17 – Wage Determination
Table from review question 2, Chapter 14:
Units
of
labor
Total
product
Marginal
product
Product
price
Total
revenue
Marginal
revenue
product
0
1
2
3
4
5
6
0
17
31
43
53
60
65
17
14
12
10
7
5
$2
2
2
2
2
2
2
$0
34
62
86
106
120
130
$34
28
24
20
14
10
3. Assume a firm is a monopsonist that can hire its first worker for $6 but must increase the wage
rate by $3 to attract each successive worker (so that the second worker must be paid $9, the third
$12, and so on). LO3
a. Draw the firm’s labor supply and marginal resource cost curves. Are the curves the same or
different? If they are different, which one is higher?
b. On the same graph, plot the labor demand data of review question 2 in Chapter 16. What are
the equilibrium wage rate and level of employment?
c. Compare these answers with those you found in problem 2. By how much does the
monoposonist reduce wages below the competitive wage? By how much does the monopsonist
reduce employment below the competitive level?
Chapter 17 – Wage Determination
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Feedback:
Parts a and b:
Table for part a and table for part b (from review question 2 in Chapter 14 and problem 2
above).
Units
of labor
Wage
Rate
Total
labor cost
(wage bill)
Marginal
resource
(labor) cost
0
1
2
3
4
5
6
$NA
6
9
12
15
18
21
$0
6
18
36
60
90
126
$6
12
18
24
30
36
MRC monopsony
Supply monopsony
$6
1
units of labor
MRP
MRC=Supply competitive
competitive wage = $14
5
monopsony wage = $12
MRC = $18
MRP = $24
3
$
units of labor
Chapter 17 – Wage Determination
17-15
Units
of
labor
Total
product
Marginal
product
Product
price
Total
revenue
Marginal
revenue
product
0
1
2
3
4
5
6
0
17
31
43
53
60
65
17
14
12
10
7
5
$2
2
2
2
2
2
2
$0
34
62
86
106
120
130
$34
28
24
20
14
10
Graph: (approximate shape below. Also note that the discreet nature of the problem
requires that the marginal revenue product (MRP) be greater than or equal to the marginal
resource cost (MRC)).
MRC monopsony
Supply monopsony
$6
1
units of labor
MRP
MRC=Supply competitive
competitive wage = $14
5
monopsony wage = $12
MRC = $18
MRP = $24
3
Chapter 17 – Wage Determination
17-16
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consent of McGraw-Hill Education.
The MRC schedule lies above the labor supply schedule because employing the next
worker requires a higher wage in this market and you must pay all workers this higher
wage.
The firm will employ three workers in this situation. To see this look at the MRP and
MRC columns in the table above. The first worker will generate a MRP = $34 and will
have a MRC = $6, thus the firm will employ this worker (the marginal revenue product
for this worker is greater than his or her marginal cost). For the second worker we have
MRP = $28 and MRC = $12, so we employ this worker. For the third worker we have
MRP = $24 is greater than the MRC = $18, so we employ this worker as well. For the
fourth worker we have MRP = $20 and the MRC = $24. In this case the marginal cost of
this worker is greater than the worker’s marginal revenue product, so we do not employ
this worker.
Part c: The monopsonist decreases employment by 2 units and the equilibrium wage rate
is $2 less than the competitive wage.
4. Suppose that low‐skilled workers employed in clearing woodland can each clear one acre per
month if each is equipped with a shovel, a machete, and a chainsaw. Clearing one acre brings in
$1,000 in revenue. Each worker’s equipment costs the worker’s employer $150 per month to rent
and each worker toils 40 hours per week for four weeks each month. LO6
a. What is the marginal revenue product of hiring one low‐skilled worker to clear woodland for
one month?
b. How much revenue per hour does each worker bring in?
c. If the minimum wage were $6.20, would the revenue per hour in part b exceed the minimum
wage? If so, by how much per hour?
d. Now consider the employer’s total costs. These include the equipment costs as well as a normal
profit of $50 per acre. If the firm pays workers the minimum wage of $6.20 per hour, what will
the firm’s economic profit or loss be per acre?
e. At what value would the minimum wage have to be set so that the firm would make zero
economic profit from employing an additional low‐skilled worker to clear woodland?
Chapter 17 – Wage Determination
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Feedback:
5. Suppose that a car dealership wishes to see if efficiency wages will help improve its
salespeople’s productivity. Currently, each salesperson sells an average of one car per day while
being paid $20 per hour for an eight‐hour day. LO8
a. What is the current labor cost per car sold?
b. Suppose that when the dealer raises the price of labor to $30 per hour the average number of
cars sold by a salesperson increases to two per day. What is now the labor cost per car sold? By
how much is it higher or lower than it was before? Has the efficiency of labor expenditures by the
firm (cars sold per dollar of wages paid to salespeople) increased or decreased?
c. Suppose that if the wage is raised a second time to $40 per hour the number of cars sold rises to
an average of 2.5 per day. What is now the labor cost per car sold?
d. If the firm’s goal is to maximize the efficiency of its labor expenditures, which of the three
hourly salary rates should it use: $20 per hour, $30 per hour, or $40 per hour?
e. By contrast, which salary maximizes the productivity of the car dealer’s workers (cars sold per
worker per day)?