For "JOYMERCY" Only!!! Assign #4

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C H A P T E R

Earnings and Discrimination

Microeconomics P R I N C I P L E S O F

N. Gregory Mankiw

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by Ron Cronovich

In this chapter,

look for the answers to these questions:

 How do wages compensate for differences in job

characteristics?

 Why do people with more education earn higher

wages?

 Why are wages sometimes above their equilibrium

values?

 Why is it difficult to measure discrimination?

 When might the market solve the problem of

discrimination? When might it not? 1

U.S. Median Weekly Earnings, Selected Occupations, 2006

Occupation Both

sexes Men Women

Gender

gap

Chief executives $1,875 $1,907 $1,422 34.1%

Aircraft pilots 1,407 1,419 n.e.d.

Educ. administrators 1,125 1,275 1017 25.4%

Fire fighters 912 918 n.e.d.

Registered nurses 978 1,074 971 10.6%

Social workers 732 749 728 2.9%

Secretaries 583 559 584 – 4.3%

Telemarketers 395 n.e.d. n.e.d

Waiters/waitresses 363 401 348 15.2%

Maids/housekeeping 355 404 348 16.1%

n.e.d. = not enough data for BLS disclosure requirements 2

EARNINGS AND DISCRIMINATION 3

Introduction

 In competitive markets, the wages workers earn

equal the value of their marginal products.

 There are many factors that affect productivity

and wages…

EARNINGS AND DISCRIMINATION 4

Compensating Differentials

 Compensating differential: a difference in wages

that arises to offset the nonmonetary characteristics

of different jobs

 These characteristics include unpleasantness,

difficulty, safety. Examples:

 Coal miners and fire fighters are paid more

than other workers with similar education

to compensate them for the extra risks.

 Night shift workers paid more than day shift

to compensate for the lifestyle disruption of

working at night.

EARNINGS AND DISCRIMINATION 5

Ability, Effort, and Chance

 Greater ability or effort often command higher

pay. These traits increase workers’ marginal

products, make them more valuable to the firm.

 Wages also affected by chance

 E.g., new discoveries no one could have

predicted make some occupations obsolete,

increase demand in others

EARNINGS AND DISCRIMINATION 6

Ability, Effort, and Chance

 Ability, effort, and chance are difficult to measure,

so it is hard to quantify their effects on wages.

 They are probably important, though,

since easily measurable characteristics

(education, age, etc.) account for less than half

of the variation in wages in our economy.

EARNINGS AND DISCRIMINATION 7

Case Study: The Benefits of Beauty

Research by Hamermesh and Biddle:

 People deemed more attractive than average

earn 5% more than people of average looks.

 Average-looking people earn 5-10% more

than below-average looking people.

EARNINGS AND DISCRIMINATION 8

Case Study: The Benefits of Beauty

Hypotheses:

1. Good looks matter for productivity

 In jobs where appearance is important,

attractive workers are more valuable to the

firm, command higher pay.

2. Good looks indirectly related to ability

 People who make an effort to project

attractive appearance may be smarter or

more competent in other ways.

3. Discrimination

EARNINGS AND DISCRIMINATION 9

The Superstar Phenomenon

 Superstars like Will Smith, Bono earn many

times more than average in their fields.

 The best plumbers or carpenters do not.

 Superstars arise in markets that have two

characteristics:

 Every customer in the market wants to enjoy the

good supplied by the best producer.

 The good is produced with a technology that

allows the best producer to supply every

customer at a low cost.

EARNINGS AND DISCRIMINATION 10

Human Capital

 Human capital: the accumulation of

investments in people, such as education and

on-the-job training

 Human capital affects productivity, and thus labor

demand and wages.

Weekly Earnings of Full-Time Employed

Persons Age 25+ by Education, 2007:Q4

Educational

attainment

Median weekly

earnings

Less than H.S. $ 424

H.S. diploma 610

Some college or

Associate degree 697

Bachelor’s degree 994

Advanced degree 1,259

EARNINGS AND DISCRIMINATION 12

The Increasing Value of Skills

Women

Men

72%

87%

2005

35%

44%

1980

Percentage difference in annual

earnings for college graduates

vs. high school diploma

The earnings gap between

college-educated and

non-college-educated workers

has widened in recent decades.

EARNINGS AND DISCRIMINATION 13

The Increasing Value of Skills

Two hypotheses:

1. International trade

Rising exports of goods made with skilled labor,

rising imports of goods made with unskilled labor.

2. Skill-biased technological change

New technologies have increased demand for

skilled workers, reduced demand for unskilled

workers.

Difficult to determine which hypothesis

better explains the widening earnings gap;

probably both are important.

Suppose you were offered this choice:

A. Spend 4 years studying at the world’s best

university, but must keep your attendance

there a secret.

B. Get an official degree from the world’s best

university, but cannot actually study there.

Which do you think would enhance your future

earnings more?

A C T I V E L E A R N I N G 1

Discussion question

EARNINGS AND DISCRIMINATION 15

The Signaling Theory of Education

An alternative view of education:

 Firms use education level to sort between

high-ability and low-ability workers.

 The difficulty of earning a college degree

demonstrates to prospective employers that

college graduates are highly capable.

 Yet, the education itself has no impact on

productivity or skills.

 Policy implication: Increasing general

educational attainment would not affect wages.

EARNINGS AND DISCRIMINATION 16

Reasons for Above-Equilibrium Wages

1. Minimum wage laws

The minimum wage may exceed the eq’m wage

of the least-skilled and experienced workers

2. Unions

Union: a worker association that bargains with

employers over wages and working conditions

Unions use their market power to obtain higher

wages; most union workers earn 10-20% more

than similar nonunion workers.

EARNINGS AND DISCRIMINATION 17

Reasons for Above-Equilibrium Wages

3. Efficiency wages

Efficiency wages: above-equilibrium wages paid

by firms to increase worker productivity

Firms may pay higher wages to reduce turnover,

increase worker effort, or attract higher-quality job

applicants.

In each case, identify which worker would earn more

and explain why.

A. The best physical therapist on the planet or

the best writer on the planet

B. A trucker that hauls produce or a trucker that

hauls hazardous waste from nuclear power plants

C. A graduate of an Ivy League college or an equally

intelligent & capable graduate of a state university

D. Someone who graduated from a state university

with a 3.7 GPA, or someone who graduated from

the same university with a 2.4 GPA

A C T I V E L E A R N I N G 2

Explaining wage differentials

A. The best physical therapist on the planet or

the best writer on the planet

The superstar phenomenon:

The best writer can service many more customers

than the best physical therapist.

B. A trucker that hauls produce or a trucker that hauls

hazardous waste from nuclear power plants

Compensating differentials:

The hazardous waste hauler earns more to

compensate for the higher risks.

A C T I V E L E A R N I N G 2

Answers

C. A graduate of an Ivy League college or an equally

intelligent & capable graduate of a state university

The signaling theory of education:

Employers assume the Ivy League grad has more

ability than the state university grad.

D. Someone who graduated from a state university

with a 3.7 GPA, or someone who graduated from

the same university with a 2.4 GPA

The human capital theory of education:

A higher GPA reflects greater learning, which

leads to higher productivity and wages.

A C T I V E L E A R N I N G 2

Answers

EARNINGS AND DISCRIMINATION 21

The Economics of Discrimination

 Discrimination: the offering of different

opportunities to similar individuals who differ only

by race, ethnicity, gender, or other personal

characteristics

EARNINGS AND DISCRIMINATION 22

Measuring Labor-Market Discrimination

 Median earnings of full-time U.S. workers, 2007:

 White males earn 21% more than white females.

 White males earn 24% more than black males.

 Taken at face value, these differences look like

evidence that employers discriminate.

 But there are many possible explanations for

wage differences besides discrimination; the data

above do not control for differences in other

factors that affect wages.

EARNINGS AND DISCRIMINATION 23

Measuring Labor-Market Discrimination Differences in human capital among groups:

 White males 75% more likely to have college

degree than black males

 White males 11% more likely to have graduate

degree than white females

 Women have less on-the-job experience than men

 Public schools in many predominantly black areas

are of lower quality (e.g., funding, class sizes)

There may well be discrimination in access to

education, but this problem occurs long before

workers enter the labor force.

EARNINGS AND DISCRIMINATION 24

Measuring Labor-Market Discrimination Recent study by Bertrand and Mullainathan finds

evidence of labor-market discrimination:

 5000 fake résumés sent in response to

“help wanted” ads.

 Half had names more common among blacks,

like Lakisha Washington or Jamal Jones.

The other half had names common among whites,

like Emily Walsh or Greg Baker.

Otherwise, the résumés were the same.

 The white names received 50% more calls from

interested employers than the black names.

EARNINGS AND DISCRIMINATION 25

Discrimination by Employers

 Competitive markets provide a natural remedy

for employer discrimination:

The profit motive…

EARNINGS AND DISCRIMINATION 26

The non-discriminating firms can hire females for a lower

wage, giving them a cost advantage and economic profits,

which attract entry of other non-discriminating firms.

DMDF

Suppose some firms discriminate against female workers.

They will hire fewer females, more males.

Result: A wage differential.

The discriminating firms will begin to lose money and be

driven out of the market.

Result: Demand for female workers increases,

demand for male workers falls until wages are equalized.

Discrimination by Employers

Male workers WF

Female workers

DM WF

EARNINGS AND DISCRIMINATION 27

Discrimination by Consumers

 Discrimination by consumers may result in

discriminatory wage differentials.

 Suppose firms care only about maximizing

profits, but customers prefer being served by

whites.

 Then firms have an incentive to hire white

workers, even if non-whites are willing to work

for lower wages.

EARNINGS AND DISCRIMINATION 28

Discrimination by Governments

 Some government policies mandate

discriminatory practices.

 apartheid in South Africa before 1994

 early 20th century U.S. laws requiring

segregation in buses and streetcars

 Such policies prevent the market from correcting

discriminatory wage differentials.

EARNINGS AND DISCRIMINATION 29

CONCLUSION  In competitive markets, workers are paid a wage

that equals the value of their marginal products.

 Many factors affect the value of marginal products

and equilibrium wages.

 The profit motive can correct discrimination by

employers, but not discrimination by customers or

discriminatory policies of governments.

 Even without discrimination, the distribution of

income may not be equitable or desirable –

a topic we explore in the following chapter.

CHAPTER SUMMARY

 Other things equal, wage differences compensate

workers for job attributes: The harder or less

pleasant a job, the more a worker is compensated.

 Workers with more human capital are more

productive and command higher wages than

workers with less human capital.

 Workers with college degrees may get better job

offers because the degree signals high natural

ability to employers.

CHAPTER SUMMARY

 Wages also may differ with natural ability, effort,

and chance.

 Wages are sometimes above their equilibrium

levels, due to minimum wage laws, the market

power of labor unions, and efficiency wages.

 Some differences in earnings are due to

discrimination on the basis of race or other

characteristics. Measuring the amount of

discrimination is difficult, though. 31

CHAPTER SUMMARY

 The profit motive tends to limit the impact of

employer discrimination on wages.

 Discrimination by consumers or governments may

lead to persisting wage differentials.