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Chapter 10 – Labor Markets, Income Distribution, and Poverty

Use the Section Summaries to preview the chapter's content.

Section Summaries
The following section summaries appear on the Student Review Cards.

10-1 – Input Markets

Input markets are the markets for the factors of production used to produce output. In
input or factor markets, the demand for an input derived from consumers’ demand for the
good or service produced with that input is called a derived demand.

10-2 – Supply and Demand in the Labor Market

In a competitive labor market, the demand for labor is determined by its marginal
revenue product (MRP), which is the additional revenue that a firm obtains from one
more unit of input. The marginal resource cost (MRC) is the amount that an extra input
adds to the firm’s total costs.
The downward-sloping demand curve for labor indicates a negative relationship
between wage and the quantity of labor demanded. Marginal revenue product is equal to
marginal product (MP) multiplied by marginal revenue.
Profits are maximized if the firm hires only to the point at which the wage equals
the expected marginal revenue product.
In the market supply curve, a positive relationship exists between the wage rate
and the quantity of labor supplied.

10-3 – Labor Market Equilibrium

The equilibrium wage and quantity in competitive markets for labor is determined by the
intersection of labor demand and labor supply. The demand curve for labor can be shifted
by increases in labor productivity and changes in the output price of the good. The labor
supply curve can be shifted by immigration and population growth, worker preferences,
nonwage income, and amenities.

10-4 – Labor Unions

Labor unions were formed to increase their members’ wages and to improve working
conditions. The union negotiates with firms through a process called collective
bargaining. Labor unions influence the quantity of union labor hired and the wages,
primarily through their ability to alter the supply of labor services.

10-5 – Income Distribution

In many economies, some individuals will have high income and others will have low
income. Age, demographic factors, institutional factors, and governmental redistribution
activities influence income distribution data. Studies indicate that income mobility is
significant in the United States—there will always be high- and low-income earners, but
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the people in those segments are likely to change. Reasons for income differences include
age, skill, human capital, and preferences toward risk and leisure. While income
inequality within nations is substantial, it is far less than income inequality among
nations.

10-6 – Poverty
The federal government measures poverty by using a set of money income thresholds that
vary by family size. The poverty rate is the percentage of the population that falls below
an income threshold set by the government called the poverty line.
A variety of programs are designed to reduce poverty and redistribute income.
These include taxes, transfer payments, welfare programs, and government subsidies.

Use the Teaching Tips to plan what key concepts you wish to emphasize.

Teaching Tips

You can also find selected teaching tips from this list located on your Chapter 10
Instructor Prep Card.

• As an extension of the derived demand discussion in the text, it is worth

discussing the fact that the resource thought to be responsible for superior
performance will be bid up in price to reflect that market judgment (but mistakes
can be made because identifying the responsible party is difficult in a team
productive process).
• Remind students that labor hiring and pricing decisions are just one more example
of the expected marginal benefit (marginal revenue product) versus expected
marginal cost (wage) rule of rational choice.
• A good classroom check of student understanding of this material is to ask them
why the marginal product of the “last” worker will rise if the wage is increased.
(It is not that the worker will necessarily change her productivity, but that an
employer will lay off those whose marginal products are below the new higher
wage.)
• Make sure students see that a horizontal labor supply curve to a firm in
competitive labor markets (firms as wage takers) is the analog to being a price
taker in the output markets in the perfect competition model. As in that case, it is
worth emphasizing the consistency of even a relatively inelastic market supply
curve of labor with the perfectly elastic supply curve of labor to a firm.
• To remind students not to forget the power of their supply and demand skills
beyond a single application in a single market, it could be worth extending the
text illustration of a fall in input prices in one market to the expected effect on
complementary and substitute inputs, as well as on the derived demand for inputs
in other industries whose outputs are complements or substitutes to the output of
the initial industry in question.

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 • Emphasize to students that cost minimization does not mean cutting every
possible corner on safety, on-the-job training, etc. Rather, it means that those
fringe benefits (including added safety and training) employers believe employees
value at more than the after-tax cost will be provided, but wages will be lowered
by the amount of those costs (still leaving employees better off in real terms).
• Many universities’ pay scales are based on rank (where an equal rank implies an
equal salary), yet the equilibrium wage varies, often substantially, by discipline.
You could show students how a university could give professors in different fields
different real compensation packages, without violating the equal pay for equal
rank principle, by offering extra summer school money, fewer courses or
preparations for the same salary, extra research money, more teaching assistants
and graders, more sabbaticals, better computers, etc.
• An extension of the amenities discussion might be to ask the question of how
much salaries would have to be increased to compensate professors for giving up
the security of tenure if they already have it.
• A good extension of the labor supply and demand analysis here is to discuss why
workers bear the incidence of their employer’s half of their Social Security and
Medicare taxes, and why such burdens placed on employees means that workers
are being underpaid (where they receive less than their added product in added
take home pay) at the margin in an equilibrium condition.
• Note the substantial difference in the data when one looks at total compensation
instead of wages, making it misleading to look at wages alone. One way to do this
is to talk about the effects of mandated benefits as an example.
• You may want to ask students whether it would make a difference if all people
were trained more, rather than just a relatively small number. The market supply
curve would shift right along with the demand for those workers (due to their
increased productivity), changing the results. As a particular example, you could
ask what would happen to the college education premium in the job market if far
more people went to college. This case of increasing the relevant labor supply can
also be contrasted with the case of union restriction of labor supply.
• An interesting classroom topic is to draw a connection between why unionization
is far greater when the unions deal with governments rather than with for-profit
employers and the different incentives the employers face in the two situations.
• As an extension of the text discussion of the role of unions, you can ask students
when would unions that both increase workers’ marginal productivity and restrict
the supply of labor to a group of firms cause greater employment at the resulting
higher wages? That would only be the case if they shifted workers’ marginal
products (labor demand) up more than the supply of labor curve shifted up (left).
• A good discussion topic is to ask why unions would lobby for prevailing wage
laws (especially when the prevailing wage is considered the union wage) in their
industries. The answer: It raises the cost of hiring nonunion labor relative to the
cost of hiring union labor, increasing the demand for union labor.
• If unionization reduces employment in an industry, you should note to students
that the higher union wage does not raise wages in other industries. Rather, it
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134
 increases the supply of labor to nonunionized industries, pushing down wages in
those industries.
• A good in-class test of whether students understand life-cycle effects in
evaluating income redistribution is to ask them why efforts to redistribute from
those with current high incomes to those with current low incomes entail
redistributing from you to yourself in large part. Because you are relatively rich in
your peak earning years and relatively poor when you are young and old, this
involves redistributing from you in middle age to yourself when you are young
and old.
• Note to students that differentials in average wages for different groups are
substantially biased by differences in the age distribution across those groups.
Relatively young groups will look relatively poorer, and more middle-aged
groups will look richer.
• There are several interesting classroom discussion questions that can be based on
this material. For instance: How can a decrease in the top tax bracket affect
secondary workers more than primary workers? Who gets the biggest tax cut?
What would this do to the incentives for high-income men to marry high-income
women, or to form DINK (double income no kids) households, and thus to
measures of family inequality?
• Note that if noncash benefits (which are not counted in official income
distribution measures) increase for low-income people, it may cause reductions in
the measured earnings of low-income people as they respond to the increased
incentives to remain or become eligible (e.g., Medicaid), and appear to worsen
measured inequality at the same time it actually benefits those with low income.
• Note to students that given the progressive nature of the income tax, expanding
generally available programs from income tax revenues (e.g., Medicare), can
substantially redistribute income from higher-income taxpayers to lower-income
recipients.
• An interesting classroom discussion starter question about income redistribution
is: Is it fair to help the poor through government, funded by taxation? This can
trigger a discussion of the different meanings people attach to “fair,” particularly
the difference between egalitarian views of fairness (we help the poor because
their humanity means they deserve it) and libertarian views of fairness (it is unfair
to involuntarily take my income, which was voluntarily paid to me by others,
through taxation, for government spending I do not support).
• A connection between measurement issues and poverty issues can be drawn by
discussing how over-indexing the poverty line by tying it to changes in the
consumer price index has affected the number of people officially in poverty.
• A welfare reform extension you might find useful is to ask students why it gets
progressively harder to move people on welfare to work as the number of people
on welfare shrinks. (It takes a bigger increase in skills to get the remaining people
jobs than it did for those who have already gotten jobs.)
• A current policy that you may want to discuss in class is the earned income tax
credit (EITC) because it acts as a wage subsidy (at least over the range of income
where earnings are subsidized).
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135
 • You might want to point out that if there are large life-cycle effects, apparent
redistribution from currently higher-income households to currently lower-income
households is largely redistribution from the same people when they are in their
peak earning years to themselves when they are young and when they are old.
• The text discussion of the negative income tax mentions that a NIT has a work
disincentive effect. You might want to ask students if it has a greater disincentive
effect than what it would replace. It is not clear that it would, because many of the
programs it is intended to replace also take away benefits as income increases.
You might then ask them about disincentive effects if a NIT was added onto the
current welfare system rather than substituted for it. Then it is clear that the
cumulative benefit reduction rate (which acts as an income tax rate) would be
larger than before.

If you wish to use the PowerPoint slides, use the Chapter Outline to plan your
lecture.

Chapter Outline

PowerPoint Slides 10-1 – Input Markets

3–4

PowerPoint Slide 5 Approximately 75 percent of national income goes to wages and salaries for
Input Markets labor services. The rest goes to owners of land and capital and the
entrepreneurs who employ those resources to produce valued goods and
services.

PowerPoint Slide 6 In input or factor markets, the demand for an input is a derived demand—
Determining the Price derived from consumers’ demand for the good or service. The “price” of a
of a Productive productive factor is directly related to consumer demand for the final good or
Factor: Derived service.
Demand

PowerPoint Slide 7 Section Check 1

PowerPoint Slides 10-2 – Supply and Demand in the Labor Market

8–9

PowerPoint Slide 10 Because firms are trying to maximize their profits, they try to make the
Supply and Demand difference between total revenue and total cost as large as possible. An input’s
in the Labor Market attractiveness, then, varies with what the resource can add to the revenues
received by the firm relative to what it adds to costs.

PowerPoint Slides A. Will Hiring That Input Add More to Revenue than Costs?
11–12
Will Hiring That The demand for labor is determined by its marginal revenue product (MRP),
Input Add More to which is the additional revenue that a firm obtains from one more unit of input.
Revenue than Costs?
The marginal resource cost (MRC) is the amount that an extra input adds to
the firm’s total costs. In a competitive labor market, its MRC is the market
wage the employer has to pay to entice an extra worker.
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136
 A firm would find its profits growing by adding one more worker when the
marginal revenue product associated with the worker exceeds the marginal
resource cost of the worker. However, additional hiring would be unprofitable
when the marginal resource cost exceeds the marginal revenue product.

PowerPoint Slides B. The Demand Curve for Labor Slopes Downward

13–14
The Demand Curve The demand curve for labor slopes downward. Higher wages will decrease the
for Labor Slopes quantity of labor demanded, while lower wages will increase the quantity of
Downward labor demanded.

PowerPoint Slide 15 Ex.10.1 – The Marginal Revenue Product of Labor

Exhibit 10.1
The major reason for the downward-sloping demand curve for labor is the law
of diminishing marginal product. The added output associated with one more
worker—marginal product—declines as more workers are added because as
more workers are added, each additional worker has fewer of the fixed
resources with which to work.

PowerPoint Slide 16 Ex.10.2 – Diminishing Marginal Productivity on a Hypothetical Farm

Exhibit 10.2

PowerPoint Slides The marginal revenue product (MRP) is the change in total revenue associated
17–21 with an additional unit of input. The marginal revenue product is equal to the
Marginal Revenue marginal product (the units of output added by a worker), multiplied by
Product marginal revenue (MR) (the price of the output).

The marginal revenue product of labor declines because of the diminishing

marginal product of labor.

PowerPoint Slide 22 Ex.10.3 – Marginal Revenue Product, Output, and Labor Inputs
Exhibit 10.3

PowerPoint Slides C. How Many Workers Will an Employer Hire?

23–26
How Many Workers Profits are maximized if a firm hires only to the point where the wage equals
Will an Employer the expected marginal revenue product; that is, the firm will hire up to the last
Hire? unit of input for which the marginal revenue product is expected to exceed the
wage. Therefore, the marginal revenue product (MRP) is the same as the
demand curve for labor for a competitive firm. It is why raising wages, ceteris
paribus, lowers employment.

In a competitive labor market, many firms are competing for workers and no
single firm is big enough by itself to have any significant effect on the level of
wages. The firm is a wage taker. The ability to hire all you wish at the
prevailing wage is analogous to perfect competition in output markets, where a
firm could sell all it wanted at the going price.

PowerPoint Slide 27 Ex.10.4 – The Competitive Firm’s Hiring Decision

Exhibit 10.4

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137
PowerPoint Slide 28
The Market Labor
Supply Curve
D. The Market Labor Supply Curve
Just as was the case in our earlier discussions of the law of supply, there is a
positive relationship between wage level and the quantity of labor supplied. As
the wage rate rises, the quantity of labor supplied increases, ceteris paribus; as
the wage falls, the quantity of labor supplied falls, ceteris paribus.

PowerPoint Slide 29 Ex.10.5 – The Market Supply Curve of Labor

Exhibit 10.5

PowerPoint Slide 30 Section Check 2

PowerPoint Slides 10-3 – Labor Market Equilibrium

31–32

PowerPoint Slides At any wage higher than the equilibrium wage, the quantity of labor supplied
33–35 exceeds the quantity of labor demanded, resulting in a surplus of labor. In this
Labor Market situation, unemployed workers will be willing to undercut the established wage
Equilibrium in order to get jobs, pushing the wage down and returning the market to
equilibrium.

At a wage below the equilibrium level, quantity demanded would exceed

quantity supplied, resulting in a labor shortage. In this situation, employers
would be forced to offer higher wages in order to hire as many workers as they
would like.

Only at the equilibrium wage are both suppliers (workers) and demanders
(employers) able to exchange the quantity of labor they desire.

PowerPoint Slide 36 Ex.10.6 – Supply and Demand in the Competitive Labor Market
Exhibit 10.6

PowerPoint Slide 37 A. Shifts in the Labor Demand Curve

Shifts in the Labor
Demand Curve In the case of an input such as labor, two important factors can shift the
demand curve:
1. increases in labor productivity (technological advances, for instance)
2. changes in the output price of the good (increased demand for the firm’s
product)

PowerPoint Slide 38 Ex.10.7 – Shifts in the Labor Demand Curve

Exhibit 10.7

PowerPoint Slides Workers can increase productivity if they have more capital or land with which
39–40 to work, if technological improvements occur, or if they acquire additional
Changes in Labor skills or more experience. An increase (decrease) in productivity will increase
Productivity (decrease) the marginal product of labor and shift the demand curve for labor to
the right (left).

PowerPoint Slides The greater the demand for the firm’s product, the greater the firm’s demand
41–42 for labor or any other variable input. The higher (lower) demand for the firm's
Changes in the product increases (decreases) the firm’s marginal revenue, which increases
Demand for the (decreases) marginal revenue product.
Firm’s Product
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138
PowerPoint Slide 43 B. Shifting the Labor Supply Curve
Shifting the Labor
Supply Curve

PowerPoint Slide 44 Several factors can cause the labor supply curve to shift, including immigration
Immigration and and population growth, the number of hours workers are willing to work at a
Population Growth given wage (worker tastes or preferences), nonwage income, and amenities.

If new workers enter the labor force, it will shift the labor supply curve to the
right. If there are fewer workers in the labor force, it will cause the labor supply
curve to shift to the left.

PowerPoint Slide 45 If people become willing to work more hours at a given wage (due to changes
Number of Hours in worker tastes or preferences), the labor supply curve will shift to the right. If
People Are Willing to they become willing to work fewer hours at a given wage, the labor supply
Work curve will shift to the left.

PowerPoint Slide 46 Increases in income from sources other than employment can cause the labor
Nonwage Income supply curve to shift to the left. A decrease in nonwage income might push a
person back into the labor force, thus shifting the labor supply curve to the
right.

PowerPoint Slide 47 Amenities associated with a job will make for a more desirable work
Amenities atmosphere, ceteris paribus. These amenities would cause an increase, or
rightward shift, in the supply of labor. If job conditions deteriorate, it would
lead to a reduction, or leftward shift, in the labor supply curve.

PowerPoint Slide 48 Ex.10.8 – Shifts in the Labor Supply Curve

Exhibit 10.8

PowerPoint Slide 49 Section Check 3

PowerPoint Slides 10-4 – Labor Unions

50–51

PowerPoint Slide 52 While the percentage of workers in labor unions in the U.S. has fallen sharply
Labor Unions over the last 60 years, unions can still exert a significant influence on markets.

PowerPoint Slides A. Why Are There Labor Unions?

53–54
Why Are There Labor unions are formed to increase their members’ wages and to improve
Labor Unions? working conditions. Workers realize that acting together, as a union of workers,
they have more collective bargaining power than acting individually.

PowerPoint Slides B. Union Impact on Labor Supply and Wages

55–57
Union Impact on Labor unions influence the quantity of union labor hired and the wages at
Labor Supply and which they are hired primarily through their ability to alter the supply of labor
Wages services to employers compared to what would exist if workers acted
independently. By raising barriers to entry into a given occupation, say, by
restricting membership, unions can reduce the quantity of labor supplied to
industry employers, and as a result, increase wages in that occupation.

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139
PowerPoint Slide 58 Ex.10.9 – The Effect of Unions on Wages
Exhibit 10.9
Unions raise wages above what would prevail in a competitive labor markets,
causing:
1. some workers to be unemployed
2. lower wages in the nonunion sector
Wages are approximately 15 percent higher in union jobs.

PowerPoint Slides C. Wage Differences for Similarly Skilled Workers

59–60
Wage Differences for If unions are successful in obtaining higher wages, that will also cause
Similarly Skilled employment to fall in the union sector. With a downward-sloping demand
Workers curve for labor, higher wages mean that less labor will be demanded in the
union sector. Those workers with equal skills but unable to find union work
will seek nonunion work, thus increasing supply in that sector and, in turn,
lowering wages in the nonunion sector. Thus, comparably skilled workers will
experience higher wages in the union sector than in the nonunion sector.

PowerPoint Slide 61 D. Can Unions Lead to Increased Productivity?

Can Unions Lead to
Increased Some economists argue that unions might actually increase worker productivity
Productivity? by increasing marginal productivity because unions provide a collective voice
that workers can use to communicate their discontents more effectively. This
might lower the number of union workers that quit their jobs, which is costly
for firms. In addition, by handling worker’s grievances, unions may increase
workers’ motivation and morale.

Fewer resignations and improved morale could boost productivity. However, it

appears that unions tend to lower the profitability of firms, not raise it.

PowerPoint Slide 62 Section Check 4

PowerPoint Slides 10-5 – Income Distribution

63–64

PowerPoint Slide 65 A. Measuring Income Inequality

Income Distribution
Exhibit 10.10 shows a breakdown of average annual family income by
quintiles.

PowerPoint Slide 66 Ex.10.10 – Income Distribution of the United States, 2008

Exhibit 10.10

PowerPoint Slide 67 Exhibit 10.11 illustrates the changing distribution of measured income in the
Measuring Income U.S. since 1935.
Inequality

PowerPoint Slide 68 Ex.10.11 – Income Inequality in the United States

Exhibit 10.11
Since the 1980s, the lowest quintile has seen its share of measured income fall
from 5.3 percent to 4.0 percent, and the highest quintile has seen its share rise
from 41.1 percent to 47.8 percent.

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PowerPoint Slide 69
Are We Overstating
the Disparity in the
Distribution of
Income?
PowerPoint Slide 70
Differences in Age
PowerPoint Slide 71
Other Demographic
Trends
PowerPoint Slides
72–76
Government
Activities
PowerPoint Slides
77–79
How Much
Movement Happens
on the Economic
Ladder?
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B. Are We Overstating the Disparity in the Distribution of Income?
Failing to take into consideration differences in age, certain demographic
factors, institutional factors, and government redistributive activities have all
been identified as elements that influence the income distribution data and
suggest that we might be overstating inequality.
At any moment in time, middle-age people tend to have higher incomes than
younger and older people because they are at an age when their productivity is
at a peak and they are participating in the labor force to a greater extent.
Inequality resulting from this demographic difference overstates the true
inequality in the lifetime earnings of people.
Other demographic trends, like the increased number of divorced couples and
the rise of two-income families, have also caused the measured distribution of
income (measured in terms of household or family income) to appear more
unequal.
Some economists argue that the impact of increased government activity
should be considered in evaluating the measured income distribution.
Government-imposed taxes burden different income groups in different ways,
and government programs benefit some groups of income recipients more than
others.
Food stamps, school lunch programs, housing subsidies, Medicaid, and several
other programs provide recipients with in-kind transfers, which are given in
the form of goods and services.
On balance, the evidence suggests that inequality of money income in the
United States declined from 1935 to 1950 and then remained rather stable until
1980. Since then, the distribution of income has become less equal. However, if
we consider age distribution, institutional factors, and in-kind transfer
programs, it is safe to say that the income distribution is considerably more
equal than it appears.
C. How Much Movement Happens on the Economic Ladder?
A study of income mobility during the decade of 1985–1995 found that less
than 50 percent of individuals who began in the poorest quintile ended up there,
and almost 30 percent of those in the poorest quintile moved up to the top three
quintiles.
Roughly 80 percent of individuals in the top quintile were still there a decade
later.
The middle quintiles appear to experience considerable movement up and
down the income ladder.
On the whole, most Americans experience significant fluctuations in their
economic well-being from one year to the next.
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PowerPoint Slide 80 D. Why Do Some Earn More than Others?
Why Do Some Earn
More than Others? Some reasons for income differences include differences in age, skill, human
capital (education and training), and preferences toward risk and leisure.

PowerPoint Slide 81 As productivity increases, workers can command higher wages. Younger
Age people, with few skills, tend to make little income when they begin their
working careers. Wage earnings generally increase up to the age of 50 and fall
dramatically at retirement age.

PowerPoint Slides Some workers are just more productive than others and therefore earn higher
82–83 wages. Greater productivity can be a result of innate skills or improvements in
Skills and Human human capital.
Capital

PowerPoint Slide 84 Ex.10.12 – Education and Earnings, 2008

Exhibit 10.12

PowerPoint Slides Those that work longer hours or more intensely earn more. Those that prefer
85–86 more amenities at work or more time for leisure earn less. Those that work in
Worker Preferences riskier or more unpleasant jobs earn more, as compensation.

PowerPoint Slide 87 E. Income Distribution in Other Countries

Income Distribution
in Other Countries Despite difficulties in measurement, international comparisons of income
distribution have been made.

Income inequality is greater in the United States and United Kingdom than in
Sweden and Japan. However, many developed countries have more equal
distributions of income than developing countries, such as Mexico, South
Africa, and Brazil.

PowerPoint Slide 88 Ex.10.13 – Global Income Inequalities

Exhibit 10.13
Although income inequality within nations is often substantial, it is far less
than income inequality among nations. A majority of income inequality reflects
differences in living standards among countries rather than disparities within
nations.

PowerPoint Slide 89 Section Check 5

PowerPoint Slides 10-6 – Poverty

90–91

PowerPoint Slide 92 Our concern over income distribution largely arises because most people
Poverty believe that those with low incomes have lower satisfaction than those with
higher incomes.

PowerPoint Slides A. Defining Poverty

93–95
Defining Poverty The federal government measures poverty by using a set of money income
thresholds that vary by family size and are adjusted for inflation. If the family’s
total income is less than the established threshold, it is considered poor.

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142
 The poverty rate is the percentage of the population that falls below this
absolute level, called the poverty line.

The poverty rate for the United States is currently set at three times the cost of
providing a nutritionally adequate diet—roughly $20,000 for a family of four
(this does not include noncash benefits).

PowerPoint Slide 96 Ex.10.14 – Poverty Rate: 1959 to 2008

Exhibit 10.14
Poverty rates vary considerably among races and by household status.

PowerPoint Slide 97 Ex.10.15 – Poverty among Different Groups, 2008

Exhibit 10.15

PowerPoint Slide 98 B. Income Redistribution

Income
Redistribution Programs designed to reduce poverty and redistribute income include a
progressive income tax system, transfer payments, Social Security, Medicare,
unemployment compensation, welfare programs, the negative income tax, and
government subsidies.

PowerPoint Slide 99 A progressive tax system is one that imposes higher marginal tax rates on
Taxes higher incomes.

PowerPoint Slides Transfer payments are payments made to individuals, for which goods or
100–102 services are exchanged. Cash transfers are direct cash payments such as
Transfer Payments welfare, Social Security, and unemployment compensation.

Social Security is a cash transfer system that provides income primarily to

older people. Medicare is an in-kind transfer. Unemployment compensation is
also a social insurance form of transfer payments. All three of these forms of
social insurance programs are event based.

PowerPoint Slides Supplemental Security Income (SSI) is a welfare program designed for the
103–104 most needy, elderly, disabled, and blind. Temporary Assistance for Needy
Welfare Programs Families (TANF) is designed to help families that have few financial
resources. The Earned Income Tax Credit (EITC) is a welfare program that
allows the working poor to receive income refunds that can be greater than the
taxes they paid during the last year. It is one example of a means-tested
income transfer program in which eligibility is dependent on low income.

PowerPoint Slides A negative income tax collects taxes from high-income families and gives
105–108 subsidies to low-income families. Many economists favor a negative income
Negative Income Tax tax. It would not require the massive bureaucracy that now exists, allowing
those resources to be spent on other priorities. No one would have to
demonstrate need. It would not encourage illegitimate births or family break-
ups. However, opponents argue that if other programs cannot be dismantled, it
would be just one more facet of the welfare system, that it would have a work
disincentive effect, that it might lead to poor consumption choices, and that
while it subsidizes the unfortunate, it also subsidizes the lazy and undeserving.

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PowerPoint Slides Government revenues can be used to provide low-cost public services, for
109–111 example, inexpensive public housing, subsidized public transport, and “free”
Government public education. Not all government programs, however, benefit the relatively
Subsidies poor at the expense of the rich.

PowerPoint Slide Section Check 6

112

Key Terms

cash transfers marginal product (MP) poverty rate

collective bargaining marginal resource cost progressive tax system
(MRC)
derived demand marginal revenue product Supplemental Security
(MRP) Income (SSI)
Earned Income Tax means-tested income Temporary Assistance for
Credit (EITC) transfer program Needy Families (TANF)
in-kind transfers poverty line

Key Formulas
The Student Review Card Deck has a card devoted to the key economic formulas covered
in this text. The following are the key formulas in Chapter 10:

Unemployment Rate
Marginal revenue product = marginal product × price of the product
MRP = MP × P

You can use the following videos to supplement the discussion of topics in this
chapter. You can find them at www.cengagebrain.com. At the home page, search for
the ISBN of your title (from the back cover of your book) using the search box at the
top of the page. This will take you to the product page where the videos can be
found.

Videos

BBC Videos
1. Family Tree of Recession – Something to think about as you watch the video:
Recession affects jobs in many industries. How are the employment effects of
recession tied together by the labor market?

Ask the Instructor Videos

1. How would a zero-radius lawn mower affect your productivity? – With a
conventional riding lawn mower you waste a lot of time at the corners of the
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
144
 yard because a conventional mower requires a lot of space to turn around. In
contrast, a so-called zero-radius mower will turn in much less space. The
economic concepts involved here are marginal physical product and marginal
revenue product. The new mower is an example of a capital good that
embodies advanced technology. It allows you to become more productive and
therefore increase your earnings.
2. What’s the best thing workers can do to increase their value? – In a market
economy a person's earnings depend, with notable exceptions, upon what
economists call marginal revenue product. This is simply the product of the
worker's marginal physical product and the price at which the worker's
employer sells the finished good or service. In general, education and training
is best things that workers can do to increase their value in the labor market.
Economists frequently refer to education and on-the-job training as
investment in human capital.
3. Why do language teachers earn less? – It may offend some people to say this,
but the fact is that society values what accounting teachers do more than what
language teachers do. And in a market economy, people are rewarded based
on two things: how productive they are and how society values what they
produce. In addition, in a market economy, people are paid approximately
equal to their opportunity cost. The opportunity cost (what they could earn
outside of teaching) for accounting professors is usually much greater than for
language teachers.
4. Should you have gone to college? – Investment is an important prerequisite to
increased productivity. Economists often refer to college, and any type of
education or training, as investment in human capital. Studies show that the
rate of return from a college education is about 12 percent. Of course whether
or not your particular rate of return will be that high depends on a lot of
factors including your grades, your major, and how long you will be in the
labor force.
Graphing Workshops
1. Demand for Labor – In product markets, households are the demanders and
business firms are the suppliers. But there is another kind of market in which
the roles are reversed. In factor markets, such as the market for labor, it is
firms that do the demanding and households that supply the factors of
production.
2. Union Effects on Wages – This tutorial investigates three ways in which labor
unions might act to increase the wages of their members.
3. The Effects of a Wage Differential – Resource owners have a strong incentive
to offer their resources where they are most highly valued. In this tutorial we
will see how the existence of a wage differential triggers changes that cause
that differential to shrink or even disappear.

You can use the Self-Review as a check of student learning. If students cannot
answer questions for a section, plan to reteach that content.

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Chapter 10 – Self-Review: Questions and Answers
You can find the following quiz on page 210 at the end of Chapter 10. Students can find
answers to this quiz online at www.cengagebrain.com.

10-1–Input Markets
1. Why is the demand for tractors and fertilizer derived from the demand for
agricultural products?
The reason farmers demand tractors and fertilizer is that they increase the output of
crops they grow. But the higher the price of the crops, the greater the value to farmers
of the additional crops they can grow as a result. Therefore, the greater the demand
for those crops, ceteris paribus, the higher the price of those crops, which increases
the demand for tractors and fertilizer by increasing the value to farmers of the added
output they make possible.

10-2–Supply and Demand in the Labor Market

2. True or False: A firm will hire another worker if the marginal revenue product
of labor exceeds the market wage rate.
True. A firm would hire another worker if the marginal revenue product of labor
exceeded the market wage rate because doing so would add more to its total revenue
than it would add to its total costs, raising profits.
3. Why does the marginal product of labor eventually fall?
As more and more units of the variable input labor are added to a given quantity of
the fixed input, land or capital, the additional output from each additional unit of
labor must begin to fall at some point. This is the law of diminishing marginal
product.

10-3–Labor Market Equilibrium

4. True or False: If wages were above their equilibrium level, they would tend to
fall toward the equilibrium level.
True. If wages were above their equilibrium level, the quantity of labor supplied at
that price would exceed the quantity of labor demanded at that price. The resulting
surplus of labor would lead workers, frustrated by their inability to get jobs, to
compete down the wage for those jobs toward the equilibrium level.
5. Why do increases in technology or increases in the amounts of capital or other
complementary inputs increase the demand for labor?
Increases in technology or increases in the amounts of capital or other complementary
inputs increase the demand for labor by increasing the productivity of labor; as labor
productivity increases, the marginal revenue product of labor (the demand for labor)
increases.

10-4–Labor Unions
6. Why are service industries harder to unionize than are manufacturing
industries?

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146
 Service industries tend to be harder to unionize than manufacturing industries because
service industry jobs tend to be less standardized and service industry firms tend to be
smaller.
7. How do union restrictions on membership or other barriers to entry affect the
wages of members?
Union restrictions on membership or other barriers to entry reduce the quantity of
labor services offered to employers, reducing the number of such jobs and increasing
their wages.

10-5–Income Distribution
8. How does the growth of both two-earner families and divorced couples increase
measured income inequality?
Combining two incomes as the income of one family and increasing the number of
lower-income female-headed households due to divorce increase the number of
families counted at both the upper and lower ends of the income distribution,
increasing measured income inequality.
9. How might each of the following affect the distribution of income in the near
term?
a. There is a massive influx of low-skilled immigrants.—This would increase the
proportion of the overall population earning low incomes.
b. A new baby boom occurs.—Some individuals would opt to become full-time
parents, transforming two-income families into single-income families. This would
tend to reduce the proportion of the population in high-income quintiles and
increase the proportion in the low-income quintiles.
c. The new baby boomers enter their 20s.—When the babies in part (b) enter their
twenties and begin working, the proportion of the population in low-income
quintiles will likely increase (because young workers earn lower incomes on
average than do middle-aged workers).
d. The new baby boomers reach age 65 or older.—When the babies in part (b)
reach age 65 or older, again the proportion of the population in low-income
quintiles will increase (because retirees earn lower incomes on average than do
middle-aged workers).
e. There is an increase in cash transfer payments, such as Supplemental Security
Income.—An increase in cash transfer payments, which are focused on lower-
income earners and are counted in the official income data, will reduce the extent
of measured income inequality.
f. There is an increase in in-kind transfer payments, such as food stamps.—An
increase in noncash transfer payments, which are not counted in the official
income data, would do nothing to directly reduce measured income inequality.

10-6–Poverty
10. What are some of the programs designed to reduce poverty and redistribute
income?
These programs include progressive income taxes; transfer payments such as Social
Security, Medicare, and unemployment compensation; welfare programs such as
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147
 Supplemental Security Income and Temporary Assistance to Needy Families; the
Earned Income Tax Credit; government subsidies; and minimum wage laws.

You can use the following questions and exercises to work with students as part of
your in-class discussion. You might also use them as an in-class quiz or give them to
students as an independent homework assignment.

Class Exercises
Note: Problem 1 could alternately be used as an in-class exercise.
1. The following table shows the Total Output each week of workers on a perfectly
competitive cherry farm. The equilibrium price of a pound of cherries is $4.
Complete the Marginal Product of Labor and the Marginal Revenue Product of
Labor columns in the table. Then using the table answer the following questions.
a. How many workers will the farmer hire if the equilibrium wage rate is $550
per week?
b. $650 per week?

Answers (in bold):

Quality of Labor Total Output
Marginal Product Value of Marginal
of Labor Product of Labor
0 / / /
1 250 250 $1,000
2 600 350 $1,400
3 900 300 $1,200
4 1,125 225 $900
5 1,300 175 $700
6 1,450 150 $600
7 1,560 110 $440
a. Six workers will be hired if the equilibrium wage rate equals $550 per
week.
b. Five workers will be hired if the wage rate equals $650.

2. If a competitive firm is paying $8 per hour (with no fringe benefits) to its

employees, what would tend to happen to its equilibrium wage if the company
began to give on-the-job training or free health insurance to its workers? What
would happen to the firm’s on-the-job training and workers’ health insurance if
the government mandated a minimum wage of $9 an hour?

Answer: The equilibrium wage would tend to decrease if a company

provided on-the-job training and health benefits to its workers (because part
of the compensation to employees would come in the form of these benefits.)
If the government mandated a minimum wage of $9 per hour, employers

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148
 would likely reduce benefits such as health insurance and on-the-job training
in response.

3. Answer the following questions.

a. If every individual earned the same total income over his or her lifetime, why
would we still see inequality at a given point in time?
b. Why could means-tested income redistribution be described, at least in part, as
redistributing from you to yourself?

Answer:
a. Even with the same lifetime incomes, some would be in their peak earning
years and others would be in low earning years (e.g., those young or
retired) at a given point in time, resulting in current income inequality.
b. Means-tested programs are designed to redistribute income from higher-
to lower-income individuals at a given point in time. But most individuals
go through a life-cycle of income, with relatively high incomes during peak
earning years and relatively low incomes during other years when they are
young or in retirement. Therefore, means-tested programs partly
redistribute income away from people when they are in their peak earning
years and toward the same people when they are in their lower earning
years—redistributing from you to yourself.

Note: Problem 4 might alternately be used as a short essay assignment.

4. Consider two economies: one in which there is no redistribution of income by
government and one in which the government enforces equality of income among
everyone. Evaluate the advantages and disadvantages of each system. Which of
these two alternatives would you prefer? Given the choice, would you prefer a
system of redistribution of income that lies somewhere between these two
extremes?

Answer: In a system where there is no redistribution of income, there would

be a greater incentive to work because income taxes would undoubtedly be
lower. More people would find themselves in high-income quintiles. At the
same time, there would probably be more people in lower-income quintiles
because families in financially difficult circumstances would receive no
assistance in the form of redistributed income. If everyone in an economy
were to receive the same income, regardless of skill level or efforts, there
would be a greater incentive to slack off at work or to not work at all. People
would have far less incentive to take business risks and innovate if equality of
income were enforced. Over time, a system of equality of income might lead
to equality in poverty as economic growth is likely to slow significantly or
become negative.

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149