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323
mination
WHAT’S NEW IN THE EIGHTH EDITION:
There is a new
In the News
feature on "Schooling as a Public Investment" and a new
Ask the Experts
feature on “Inequality and Skills”. Values and tables have been updated.
LEARNING OBJECTIVES:
By the end of this chapter, students should understand:
➢ how wages compensate for differences in job characteristics.
➢ the human-capital and signaling theories of education.
LEARNING OBJECTIVES:
Chapter 19 is the second chapter in a three-chapter sequence that addresses the economics of labor
markets. Chapter 18 developed the markets for the factors of production. Chapter 19 goes beyond the
supply-and-demand models developed in Chapter 18 to help explain the wide variation in wages we find
in the economy. Chapter 20 addresses the distribution of income and the role the government can play in
altering the distribution of income.
The purpose of Chapter 19 is to extend the basic neoclassical theory of the labor market that was
developed in Chapter 18. Neoclassical theory argues that wages depend on the supply and demand for
labor and that labor demand depends on the value of the marginal productivity of labor. To address the
wide variation in the wages that occurs in the real world, it is important to examine more precisely what
determines the supply and demand for various types of labor.
EARNINGS AND
DISCRIMINATION
19
324 ❖ Chapter 19/Earnings and Discrimination
KEY POINTS:
• Workers earn different wages for many reasons. One reason is that wage differentials play a role in
compensating workers for job attributes. Other things equal, workers in hard, unpleasant jobs are
paid more than workers in easy, pleasant jobs.
• Workers with more human capital get paid more than workers with less human capital. The return to
accumulating human capital is high and has increased over the past several decades.
• Some economists have suggested that more educated workers earn higher wages not because
education raises productivity but because workers with high natural ability use education as a way to
signal their high ability to employers. If this signaling theory were correct, then increasing the
educational attainment of all workers would not raise the overall level of wages.
• Wages are sometimes pushed above the level that brings supply and demand into balance. Three
explanations of above-equilibrium wages are minimum-wage laws, unions, and efficiency wages.
• Some differences in earnings are attributable to discrimination on the basis of race, sex, or other
factors. Measuring the amount of discrimination is difficult, however, because one must correct for
differences in human capital and job characteristics.
• Competitive markets tend to limit the impact of discrimination on wages. If the wages of a group of
workers are lower than those of another group for reasons not related to marginal productivity, then
nondiscriminatory firms will be more profitable than discriminatory firms. Profit-maximizing behavior,
therefore, can reduce discriminatory wage differentials. Discrimination persists in competitive
markets, however, if customers are willing to pay more to discriminatory firms or if the government
passes laws requiring firms to discriminate.
CHAPTER OUTLINE:
I. Some Determinants of Equilibrium Wages
A. Compensating Differentials
2. Jobs that are easy, fun, or safe will pay lower wages than jobs that are difficult, dull, or
dangerous.
Most people (especially college students) have little idea about the level of earnings
in the labor force and about the extent of income differences. The general impression
is that earnings are higher than they actually are. Thus, the actual differences in
earnings among the population are a topic that most students will find interesting.
Chapter 19/Earnings and Discrimination ❖ 325
B. Human Capital
1. Definition of human capital: the accumulation of investments in people, such as
education and on-the-job training.
4.
Case Study: The Increasing Value of Skills
a. Table 1 compares the average earnings of college graduates with the average earnings
of high school graduates with no additional education.
b. We can see that there has been an increase in this difference over time.
c. One possible reason that this has occurred is that international trade has changed the
relative demand for skilled and unskilled labor.
d. Another possible reason is that changes in technology have changed the relative demand
for skilled and unskilled workers.
5.
Ask the Experts:
Inequality and Skills
a. 88 percent of economic experts agree that one of the primary causes of rising income
inequality in the US is the effect of technological change on workers with different skill
sets.
6.
In the News:
Schooling as a Public Investment
C. Ability, Effort, and Chance
1. Because of heredity and upbringing, people differ in their physical and mental attributes. This
will affect their productivity level and therefore their wage.
2. People also differ in their level of effort. Those who work hard are more productive and earn
a higher wage.
Table 1
An obvious example of a compensating wage differential is work that entails danger
and potential personal injury. A wage premium is paid to compensate workers for
exposing themselves to risk. Examples include workers in high-rise construction or
electrical linemen.
326 ❖ Chapter 19/Earnings and Discrimination
3. Chance also plays a role in determining wages.
4.
Case Study: The Benefits of Beauty
a. Daniel Hamermesh and Jeff Biddle used data from surveys conducted in the United
States and Canada to try to determine how wages are affected by physical appearance.
d. Another possible reason is that a person who is successful in making him or herself
attractive may be equally successful in other tasks.
e. A third possible reason for this difference in the wages is discrimination.
D. An Alternative View of Education: Signaling
1. Some economists have suggested that firms may use education as a way to sort high-ability
workers from low-ability workers.
2. This implies that when people earn a college degree, they do not become more productive,
but instead signal their high ability to prospective employers.
E. The Superstar Phenomenon
1. Superstars arise in markets that have two characteristics.
a. Every customer in the market wants to enjoy the good supplied by the best producer.
b. The good is produced with a technology that makes it possible for the best producer to
supply every customer at a low cost.
2. This is why we see superstars in some markets (entertainment, professional sports) and not
in others (plumbing, carpentry).
F. Above-Equilibrium Wages: Minimum-Wage Laws, Unions, and Efficiency Wages
Chapter 19/Earnings and Discrimination ❖ 327
b. Definition of union: a worker association that bargains with employers over
wages and working conditions.
c. Definition of strike: the organized withdrawal of labor from a firm by a union.
3. Above-equilibrium wages raise the quantity of labor supplied and lower the quantity
demanded, creating a surplus of labor.
II. The Economics of Discrimination
B. Measuring Labor-Market Discrimination
1. Table 2 reports median annual earnings by race and gender for 2014.
a. The median black man was paid 20% less than the median white man.
b. The median black woman was paid 17% less than the median white woman.
c. The median white woman was paid 21% less than the median white man.
d. The median black woman was paid 18% less than the median black man.
2. However, it is difficult to determine how much of the differential in wages across different
groups can be attributed to discrimination.
a. For example, the quantity of education often differs between blacks and whites.
3. Because the differences in median earnings 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.
4.
Case Study: Is Emily More Employable than Lakisha?
Table 2
328 ❖ Chapter 19/Earnings and Discrimination
a. Economists Marianne Bertrand and Sendhil Mullainatham answered more than 1,300
help-wanted ads run in Boston and Chicago newspapers by sending in nearly 5,000 fake
resumes.
C. Discrimination by Employers
1. It may be incorrect to blame employers for discrimination because each firm has a profit
motive.
2. Example: Two types of people, blondes and brunettes. Both groups have the same skills,
experience, and work ethic. But employers prefer to hire brunettes.
a. This implies that the demand for blondes is lower than it otherwise would be.
b. This also means that blondes will earn a lower wage than brunettes.
3. In this economy, there is an easy way for a firm to beat out its competitors: hire all blondes.
a. This firm would pay lower wages and therefore have lower costs.
4. Businesses that care about earning a profit are at an advantage when competing against
those that also care about discriminating.
5.
Case Study: Segregated Streetcars and the Profit Motive
a. Studies of the streetcar industry suggest that streetcars were never segregated until the
firms were required to do so by law.
b. In fact, many firms that ran the streetcars protested these laws because of the increase
in the firms' costs from the law (which meant lower profits).
D. Discrimination by Customers and Governments
1. Customer preferences may limit the ability of the profit motive to eliminate discriminatory
wage differentials.
a. If customers do not care whether they are being waited on by a blonde or a brunette,
the profit motive will work and both groups will eventually be earning the same wage.
Chapter 19/Earnings and Discrimination ❖ 329
b. If customers prefer brunettes, the entry of firms that hire blondes will not succeed in
eliminating the wage differential between blondes and brunettes.
2. Also, if the government mandates discriminatory practices, then the wage differentials
between the groups will continue to exist.
3.
Case Study: Discrimination in Sports
a. Studies of sports teams suggest that racial discrimination is common and that much of
the blame lies with the customers.
b. One study found that black basketball players earned 20% less than white players of
comparable ability did. Attendance at basketball games was also higher for teams with a
Activity 1—Even Money
Type: In-class assignment
Topics: Incentives, distribution of income
Materials needed: None
Time: 20 minutes
Class limitations: Works in any size class
Purpose
This assignment explores labor market issues by looking at an artificial situation of complete
equality. Notions of incentives and job differences are explored. This usually provokes lively
discussion, particularly if the proposal is presented as a realistic alternative.
Instructions
Have the class answer the following questions. Give them time to write an answer to a
question, then discuss their answers before moving to the next question.
Ask the students to consider replacing the current U.S. economic system with a system where
everyone is paid exactly the same salary. Assume that each family would receive an equal
share of GDP.
330 ❖ Chapter 19/Earnings and Discrimination
Common Answers and Points for Discussion
1. Would you personally favor this system? Explain.
Most students oppose a completely egalitarian distribution of income. Some expect to
earn more under the existing system. Others see a variety of problems that make
equality unworkable. Others simply see it as “un-American.”
2. What problems would exist?
Numerous problems exist. National income may fall if the incentives to work are
3. What mechanisms could be enacted to overcome these problems?
Income could still be denied to people who did not work, and workers could still be fired
for inadequate effort. Households could be required to participate in the labor force.
Unpleasant jobs could be modified to improve safety, sanitation, or difficulty. Shorter
hours could be assigned to those performing the least desirable work. In short, a
complete set of alternative incentives would have to be developed. These incentives
become increasingly complex as more and more aspects of the price system are
replaced.
4. Who would benefit from equalizing the distribution of income?
5. What jobs would be hard to fill?
Students break into two groups on this question. Many see the undesirable jobs as
menial, rote, unsafe, or unclean. Slaughterhouses, garbage disposal, and assembly-line
work are frequent examples.
A relevant follow-up question is: “Why would these jobs be hard to fill at $90,000 a
year, when people currently work these jobs for much lower wages?”
Another group of students think professional jobs would be undesirable. Doctors,
lawyers, and executives are their examples.
Ask them, “Are these jobs worse than sucking the guts out of a dead chicken? These
jobs seem to have better working conditions, high levels of personal autonomy, and
some interesting challenges. Are people in these jobs motivated by more than money?”
Chapter 19/Earnings and Discrimination ❖ 331
SOLUTIONS TO TEXT PROBLEMS:
Quick Quizzes
1. A compensating differential is a difference in wages that arises to offset the nonmonetary
2. It is hard to establish whether a group of workers is being discriminated against because
there are many reasons other than discrimination for wages to differ across workers, such as
differences in human capital and job characteristics.
Chapter Quick Quiz
1. b
Questions for Review
1. Coal miners are paid more than other workers with similar amounts of education because
3. Education might raise a worker's wage without raising the worker's productivity if education
4. The conditions that lead to highly-compensated superstars are: (1) every customer wants to
enjoy the good supplied by the best producer; and (2) the good is produced with a
332 ❖ Chapter 19/Earnings and Discrimination
5. A worker’s wage might be above the level that balances supply and demand because: (1)
minimum-wage laws raise wages above the levels that some workers would earn in an
6. Deciding whether a group of workers has a lower wage because of discrimination is difficult
7. The forces of economic competition tend to ameliorate discrimination on the basis of race,
8. Discrimination can persist in a competitive market if customers have a preference for
Problems and Applications
b. Despite the low wages, students are willing to take internships because an internship
2. The single minimum wage might distort the labor market for teenage workers more than for
adult workers because: (1) teenagers have a lower value of marginal product, so it is more
3. People with more experience usually have had more on-the-job training than others with the
4. a. Economics professors may receive higher salaries than professors in some other fields
Chapter 19/Earnings and Discrimination ❖ 333
5. Under the signaling theory, you would rather have the degree and not attend the university.
6. The development of recording devices led to a superstar phenomenon in which the best
7. a. People respond to incentives. Merit pay provides an incentive for teachers to work
harder.
8. Yes, his behavior is profit maximizing. He is hiring labor at a lower cost. You might claim that
Alan is despicable because he is discriminating against men. Some might claim that Alan was
