CHAPTER 6
Wages also will vary because workers are different.
We each bring into the labor market a unique set of
abilities and acquired skills, or human capital.
The notion of present value allows us to compare
dollar amounts spent and received in different time
periods.
4. In general, the present value of a payment of, say, y
dollars next year is given by PV = y 1 + r where r is the
rate of interest, which is also called the rate of
discount.
The figure shows the age-earnings profile (that is, the
wage path over the life cycle) associated with each
alternative.
This is the opportunity cost of going to school—the
cost of not pursuing the best alternative.
illustrates the wage-schooling locus , which gives the
salary that employers are willing to pay a particular
worker for every level of schooling.
We refer to this percentage change in earnings
resulting from one more year of school as the
marginal rate of return to schooling.
This comparison is akin to comparing apples and
oranges and is contaminated by selection bias, the
fact that workers self-select themselves into jobs for
which they are best suited.
Therefore, there is asymmetric information in the
labor market, where one of the parties in the
transaction knows more about the terms of the
contract.
High-productivity workers have an incentive to
provide and firms have an incentive to take into
account credible information that can be used to
allocate the worker into either productivity group.
This type of information is called a signal.
The different policy recommendations made by the
two approaches suggest that the private rate of
return to schooling , as measured by the increase in a
worker’s earnings resulting from an additional year of
schooling, may differ substantially from the social rate
of return to schooling , as measured by the increase
in national income resulting from the same year of
education.
There are two types of OJT:
1. general training and;
2. specific training
General training - is the type of training that, once
acquired, enhances productivity equally in all firms.
These general skills, which include such things as
typing, learning how to drive, and learning how to use
a calculator, are found frequently in the labor market.
Specific training - is the type of training that enhances
productivity only in the firm where it is acquired and
the productivity gains are lost once the worker leaves
the firm.
Examples of specific training also abound in the labor
market: learning how to drive a tank in the army or
memorizing the hierarchical nature of a particular
organization.
Specifically trained workers, therefore, will prefer to
“wait out” the unemployment spell until they are
recalled by their former employers. There is, in fact, a
very high incidence of temporary layoffs in many
labor markets.
For convenience, let’s measure the human capital
stock in efficiency units . Efficiency units are
standardized units of human capital.
In the Mincer earnings function , as this widely used
equation has come to be known, the coefficient on
schooling a estimates the percent increase in earnings
resulting from one additional year of schooling and is
typically interpreted as the rate of return
SUMMARY
• A dollar received today does not have the same
value as a dollar received tomorrow. The present
value of a future income receipt gives the value of
that amount in terms of today’s dollars.
• The wage-schooling locus gives the salary that a
worker earns if he or she completes a particular level
of schooling.
• Workers choose the point on the wage-schooling
locus that maximizes the present value of lifetime
earnings. In particular, workers quit school when the
marginal rate of return to schooling equals the rate of
discount.
• When workers differ only in their discount rates, the
rate of return to schooling can be estimated by
comparing the earnings of different workers. When
workers differ in their innate abilities, the wage
differential among workers does not measure the rate
The Gini coefficient is defined as
of return to schooling because the wage gap also
depends on the unobserved ability differential.

• Workers sort themselves into those occupations for

which they are best suited. This self-selection implies
Two commonly used measures are the
that we cannot test the hypothesis that workers
choose the schooling level that maximizes the present  90-10 wage gap and the
value of lifetime earnings by comparing the earnings  50-10 wage gap .
of different workers.
The 90-10 wage gap gives the percent wage
• In the United States, the rate of return to schooling differential between the worker at the 90th percentile
was around 9 percent in the 1990s. of the income distribution and the worker at the 10th
percentile.
• Schooling can play a signaling role in the labor
market, indicating to employers that the worker The 90-10 wage gap thus provides a measure of the
carrying the certificate or diploma is a highly range of the income distribution
productive worker. The signaling value of education
The 50-10 wage gap gives the percent wage
can help firms differentiate highly productive workers
differential between the worker at the 50th percentile
from less productive workers.
and the worker at the 10th percentile.
• If education plays only a signaling role, workers with
The 50-10 wage gap thus provides a measure of
more schooling earn more not because education
inequality between the “middle class” and low-
increases productivity, but because education signals
income workers.
a worker’s innate ability.
The demand for skilled workers may have increased
• The observed age-earnings profile is upward sloping
by more than the demand for unskilled workers
and concave. Earnings increase over the life cycle, but
because of skill-biased technological change.
at a decreasing rate.
The fact that a few persons in some professions earn
• General training is valuable in all firms. Specific
astronomically high salaries and seem to dominate
training is valuable only in the firm that provides the
the field has come to be known as the superstar
training. Workers pay for and collect the returns from
phenomenon
general training. Workers and firms share both the
costs and the returns of specific training. The link between the skills of parents and children—
or, more generally, the rate of social mobility —is at
• The optimal timing of human capital investments
the heart of many of the most hotly discussed policy
over the life cycle implies that the age-earnings profile
questions. Consider, for instance, the debate over
is upward sloping and concave.
whether the lack of social mobility in particular
segments of society contributes to the creation of an
“underclass”; or the debate over whether government
CHAPTER 7: THE WAGE STRUCTURE
policies help strengthen the link in poverty and
A positively skewed wage distribution implies that welfare dependency across generations.
the bulk of workers earn relatively low wages and that
The slope of this line is often called an
a small number of workers in the upper tail of the
intergenerational correlation . An intergenerational
distribution receive a disproportionately large share of
correlation equal to 1 (as in line A in the figure)
the rewards.
implies that if the earnings gap between any two
The line AB is called a Lorenz curve ; it reports the parents is $1,000, their children’s income also will
cumulative share of the income accruing to the differ by $1,000
various quintiles of households. The “perfect-equality”
The possible attenuation of the differences in skills or
Lorenz curve must be a straight line with a 45 angle.
incomes across generations is known as regression
toward the mean —a tendency for income
differences across families to get smaller and smaller
over time as the various families move toward the
mean income in the population
SUMMARY
• The positive correlation between human capital
investments and ability implies that the wage
distribution is positively skewed so that workers in the
upper tail of the wage distribution get a
disproportionately large share of national income.
• The Gini coefficient measures the amount of
inequality in an income distribution.
• Wage inequality rose rapidly in the 1980s and
1990s. Wage dispersion increased between education
and experience groups, as well as within narrowly
defined skill groups.
• Some of the changes in the wage structure can be
explained in terms of shifts in supply (such as
immigration), the increasing globalization of the U.S.
economy, institutional changes in the labor market
(including the de-unionization of the labor force and
the decline in the real minimum wage in the 1980s),
and skill-biased technological change. No single
variable, however, is the “smoking gun” that explains
the bulk of the changes in the wage structure.
• Superstars receive a large share of the rewards in
some occupations. The output produced by very
talented workers is not perfectly substitutable with
the output produced by less-talented workers.
Superstars arise when the highly talented can reach
very large markets at a very low price.
• Wage dispersion among workers is transmitted from
one generation to the next because parents care
about the well-being of their children and invest in
their children’s human capital. The typical
intergenerational correlation exhibits some regression
toward the mean, with the wage gap between any
two families narrowing across generations.
CHAPTER 8: LABOR MOBILITY
This chapter studies the determinants of labor
mobility , the mechanism that labor markets use to
improve the allocation of workers to firms.
Workers who have just migrated are extremely likely
to move back to their original locations (generating
return migration flows) and are also extremely likely
to
move onward to still other locations (generating
repeat migration flows).
The wife is, in effect, a tied stayer . She sacrifices the
better employment opportunities available elsewhere
because her husband is much better off in their
current region of residence.
The family moves and the husband is a tied mover .
He follows the wife even though his employment
outlook is better at their current residence.
These differences in skills across cohorts are called
cohort effects
The economic intuition underlying these arguments is
based on the influential Roy model , which describes
how workers sort themselves among employment
opportunities.
As long as the payoff for skills in the United States
exceeds the payoff for skills in the source country, all
persons who have a skill level exceeding the threshold
s P are better off in the United States. Therefore, the
migration flow is composed of workers in the upper
tail of the skill distribution illustrated in Figure 8-8 .
This type of self-selection is called positive selection. .
Immigrants, on average, are very skilled and do quite
well in the United States.
When the payoff for skills in the United States is
relatively low, therefore, the immigrant flow will be
composed of the least-skilled workers in the source
country. This type of self-selection is called negative
selection . Immigrants, on average, are unskilled and
perform poorly in the United States.
Some researchers argue that social capital —the set
of variables that characterizes the “quality” of the
environment where a person grows up or lives—also
helps determine the worker’s human capital.
In effect, the quality of the environment where the
child grows up acts as a human capital externality in
the production of the children’s human capital. In
other words, the environment is an external factor—
beyond the control of the parents—that affects the
human capital accumulation process.
The notion that each job match (that is, each
particular pairing of a firm and a worker) has its own
unique value implies that both workers and firms can
improve their situations by shopping around.
Job turnover, therefore, is the mechanism that labor
markets use to correct matching errors and leads to a
better and more efficient allocation of resources. This
type of turnover is called efficient turnover , for it
increases the total value of labor’s product in a
competitive labor market.
Summary
• The probability of moving across geographic regions
depends on economic conditions in both the
destination and origin states, and on migration costs.
The probability of migration rises when incomes are
low in the state of origin or when incomes are high in
the state of destination. The probability of migration
also rises if migration costs are low.
• If mobility decisions are made jointly by all
household members, the migration flow includes a
number of tied movers. Tied movers suffer a private
loss from the migration, but the loss is more than
outweighed by the gains of other family members.
• If there are cohort effects in the skill composition of
the immigrant flow, the fact that earlier immigrants
earn more than newly arrived immigrants in a cross
section need not indicate that immigrants experience
significant assimilation as they accumulate “U.S.-
specific” labor market experience. There seem to be
sizable cohort effects in the immigrant flow entering
the United States, with more recent waves being
relatively less skilled than earlier waves.
• Immigrants are not randomly chosen from
thepopulation of a source country. If the rate of
return to skills in the receiving country exceeds the
rate of return to skills in the country of origin, the
immigrant flow is positively selected and immigrants
have aboveaverage skills. If the rate of return to skills
in the receiving country is lower than the rate of
return to skills in the country of origin, the immigrant
flow is negatively selected and immigrants have
below-average skills.
• Efficient turnover improves the quality of the job
match between worker and firm and increases labor’s
contribution to national income.
• Workers who have been on the job for a long time
are less likely to move than younger workers. This
correlation arises because workers differ in their
turnover propensities and because specific training
reduces the probability of turnover as workers age on
the job.
CHAPTER 9: LABOR MARKET DISCRIMINATION
Becker’s theory of labor market discrimination is
based on the concept of taste discrimination. This
concept essentially translates the notion of racial
prejudice into the language of economics
In other words, even though it costs only w B dollars
to hire one person-hour of black labor, the employer
will act as if it costs w B (1 d ) dollars, where d is a
positive number and is called the discrimination
coefficient .
Some employers (perhaps black-owned firms) might
have a different type of prejudice; they prefer to hire
blacks. This type of behavior, which we call nepotism ,
implies that an employer’s utility-adjusted cost of
hiring a favored worker equals w
The underlying uncertainty encourages the employer
to use statistics about the average performance of the
group (hence the name statistical discrimination) to
predict a particular applicant’s productivity.
A discrimination-based explanation of this difference,
known as the occupational crowding hypothesis,
argues that women are intentionally segregated into
particular occupations.
The weak impact of affirmative action programs on
the economic well-being of white women has led
some observers to propose that employers adopt
comparable worth programs.
• Taste discrimination affects the employer’s hiring
decision because prejudice blinds the employer to the
true monetary costs associated with hiring a particular
worker. An employer who discriminates will act as if
the cost of hiring a black or female worker exceeds
the actual cost.
• If black and white workers are perfect substitutes in
the production process, employer discrimination leads
to the segregation of black and white workers in the
labor market and to unequal pay for equal work. The
firm’s discriminatory behavior also reduces profits.
• Employee discrimination leads to segregation of
black and white workers but does not create a wage
differential between the two groups. Customer
discrimination might create a wage differential
between black and white workers if employers cannot
“hide” blacks in positions where they have little
contact with customers.

• Wage differentials by race, ethnicity, and gender

can arise even if employers are not prejudiced. When
firms do not have complete information on a
particular worker’s productivity, they might use
aggregate characteristics of the group as an indicator
of the worker’s productivity.

Statistical discrimination leads to differential

treatment of equally skilled workers belonging to
different groups.

• The impact of discrimination on the wage structure

is measured by comparing the wages of workers who
have the same observable skills, such as educational
attainment and labor market experience, but who
belong to different racial or gender groups. If this
comparison does not control for all the dimensions in
which skills might differ across workers, our measure
of discrimination does not isolate the impact of
prejudice or statistical discrimination on the wage of
minorities and women.

• The wage ratio between black and white workers in

the United States has risen significantly in the past
few decades. In 1995, whites earned about 24 percent
more than blacks, and about half of this wage gap
could be attributed to differences in observable skills.

• The wage ratio between female and male workers in

the United States rose significantly in the 1980s and
1990s. In 1995, men earned about 33 percent more
than women. It may be the case, however, that a
sizable fraction of this wage gap can be attributed to
the fact that women, on average, have less labor
market experience than men.