Chapter 15

Wage
Determination

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
 Chapter Objectives
• Labor productivity and real
compensation
• Wage and employment
determination
• Competitive and monopsony
markets
• Unions and wage rates
• Causes of wage differentials
• “Pay-for-Performance” plans
13-2
 Labor Wages and Earnings
• Wages
– Price paid for labor
– Direct pay plus fringe benefits
• Wage rate
• Nominal wage
• Real wage
• General level of wages

13-3
Level of Wages Across Nations
Hourly Wages of Production Workers
Hourly Pay in U.S. Dollars, 2006
0 5 10 15 20 25 30 35
Germany
Sweden
Switzerland
United Kingdom
Australia
Canada
Italy
France
United States
Japan
Spain
Korea
Taiwan
Mexico
Source: U.S. Bureau of Labor Statistics, 2006
13-4
Minimum Average Hourly Wages
in Pakistan
• Minimum Salary in Pakistan raised
Rs. 12,000 (~$120) to Rs.
13,000(~$130) in the budget of
2015-2016 ,

Normal working time 8 hours/day.

minimum hourly wage is almost $0.5
 Role of Productivity
• Labor demand depends on
productivity
• U.S. labor highly productive
– Plentiful capital
– Access to abundant natural
resources
– Advanced technology
– Labor quality
– Other factors
13-6
 Real Wages
• Long run trend of average real
wages in the U.S.
– Variation across occupations
S2020
Real Wage Rate (Dollars)

S2000
S1900 S1950

D2020
D2000
D1950
D1900

Quantity of Labor
13-7
 Competitive Labor Market
• Market demand for labor
– Sum of firm demand
– Example: carpenters
• Market supply for labor
– Upward sloping
– Competition among industries
• Labor market equilibrium
– MRP = MRC rule
13-8
 Competitive Labor Market

Labor Market Individual Firm

a
S

Wage Rate (Dollars)

Wage Rate (Dollars)

e b
($10) ($10) s=MRC
WC WC

D=MRP
(∑ mrp’s)
d=mrp
c
0 QC 0 qC
(1000) (5)
Quantity of Labor Quantity of Labor

13-9
 Monopsony Model
• Employer has buying power
• Characteristics
– Single buyer
– Labor immobile
– Firm “wage maker”
• Firm labor supply upward sloping
• MRC higher than wage rate
• Equilibrium
13-10
 Monopsony Model

MRC
S
Wage Rate (Dollars)

Wc a

Wm c
MRP

0 Qm Qc

Quantity of Labor

• Examples of monopsony power 13-11

Demand Enhancement Model
• Union model
– Increase product demand
– Alter price of other inputs

S
Wage Rate (Dollars)

Increase
Wu In Demand
Wc
D2

D1
Qc Qu
Quantity of Labor
13-12
 Craft Union Model

• Effectively reduce supply labor

– Restrict immigration
– Reduce child labor
– Compulsory retirement
– Shorter workweek
• Exclusive unionism
• Occupational licensing
13-13
 Craft Union Model

S2
S1
Wage Rate (Dollars)

Wu Decrease
In Supply
Wc

Qu Qc

Quantity of Labor
13-14
 Industrial Union Model
• Inclusive unionism
– Auto and steel workers
S
Wage Rate (Dollars)

a b
Wu e

Wc

Qu Qc Qe

Quantity of Labor
13-15
 Union Models

• Are unions successful?

• Wages 15% higher on average
• Consequences:
– Higher unemployment
– Restricted ability to demand higher
wages

13-16
 Bilateral Monopoly
• Monopsony and inclusive
unionism
• Single buyer and seller
• Not uncommon
• Indeterminate outcome
• Desirability

13-17
 Bilateral Monopoly

MRC S
Wage Rate (Dollars)

Wu

Wc a

Wm

D=MRP

Qu=Qm Qc
Quantity of Labor
13-18
 Minimum Wage
• Case against minimum wage
• Case for minimum wage
• State and locally set rates
• Evidence and conclusions

13-19
 Wage Differentials
Average Annual Wages, 2007
Occupation Annual Average Wages
Surgeons $191,410
Aircraft Pilots 148,810
Petroleum Engineers 113,890
Financial Managers 106,200
Law Professors 95,510
Chemical Engineers 84,240
Dental Hygienists 64,910
Registered Nurses 62,480
Police Officers 50,670
Electricians 48,100
Travel Agents 32,190
Barbers 25,860
Retail Salespersons 24,530
Recreation Workers 23,790
Teacher Aides 22,820
Fast Food Cooks 16,860
Source: Bureau of Labor Statistics, 2006
13-20
 Labor Supply and Demand
• Differences across occupations
• Explains wage differentials
• Marginal revenue productivity
• Noncompeting groups
–Ability
–Education and training
• Compensating differences
13-21
Education and Annual Earnings
160,000
Educational

Annual Earnings (Thousands of Dollars)

140,000
Attainment

120,000
Professional Degree
100,000

80,000 Bachelor’s Degree

60,000
Associate’s Degree
40,000

20,000 High School Diploma

0
18-24 25-34 35-44 45-54 55-64 65+
Age 13-22
 Wage Differentials

• Workers prevented from moving

to higher paying jobs
• Market imperfections
– Lack of job information
– Geographic immobility
– Unions and government restraints
– Discrimination
13-23
 Pay for Performance
• The principal-agent problem
– Incentive pay plan
– Piece rates
– Commissions or royalties
– Bonuses, stock options, and profit
Sharing
– Efficiency wages
• Negative side-effects
13-24
 Are CEOs Overpaid?

• U.S. CEO salaries relatively high

• Good decisions enhance productivity
• Limited supply, high MRP
• Incentive to raise productivity at all
levels
• High salary bias by board members
• Unsettled issue

13-25
 Key Terms
• wage rate • minimum wage
• nominal wage • wage differentials
• real wage • marginal revenue
• purely competitive productivity
labor market • noncompeting groups
• monopsony • human capital
• exclusive unionism • compensating
• occupational differences
licensing • incentive pay plan
• inclusive unionism
• bilateral monopoly
13-26
Next Chapter Preview…

Rent, Interest,
and Profit

13-27