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The Wage Structure

M. Chaitanya

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1. Perfect Competition: Homogenous Workers and Jobs

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Assume that the wage of $10 in submarket a is higher than the wage in other submarkets. Assuming that jobs and workers are homogenous and information and mobility is costless, workers will leave the other submarkets for higher paying submarket a.

Homogenous Workers and Jobs


Wage rate S0a S1a $10 $8

This will decrease the labor supply in the other submarkets and increase the labor supply in submarket a (S0 to S1). The equilibrium wage rate will decrease in submarket a and rise in the other submarkets until the wage rate is the same in all submarkets ($8).
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D0a

Q0 Q1

Quantity of Labor Hours

2. The Wage Structure: Observed Differential

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Hourly Earnings By Occupational Group, 2003


Occupational Group Management, Business, And Financial Installation, Maintenance, And Repair Sales Workers Hourly Wage $26.24 17.14 15.89

Office and Administrative Support


Service Workers Farming, Fishing, And Forestry

13.73
10.96 9.81

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Hourly Earnings By Industry Group, 2003


Industry Group Finance, Insurance, Real Estate, Public Administration Mining Transportation, Warehousing, Information, and Utilities Manufacturing Construction Hourly Wage $20.99 20.22 19.81 19.27 18.51 17.31

Services
Retail Trade
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16.53
13.21

Private Manufacturing Workers Hourly Earnings By State, 2003


State
Connecticut New Jersey Massachusetts New York

Hourly Wage
$23.13 22.91 21.44 19.09

Pennsylvania
Ohio Texas Arkansas Mississippi
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18.26
18.12 17.53 14.77 13.80

3. Wage Differentials: Heterogenous Jobs

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Compensating Differentials

Compensating wage differentials consist of extra pay that an employer must provide a worker for some undesirable job characteristic that does not exist in alternative employment.
The

wage differential is caused by a decreased labor supply for the job that has the undesirable job characteristic and an increased labor supply for the alternative employment.

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Compensating Differentials

Sources of compensating differentials


Risk

of job injury or death


jobs pay higher wages

Riskier

Fringe
Jobs

benefits

with greater fringe benefits pay lower wages

Job

status

Jobs

with greater prestige pay lower wages

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Compensating Differentials
Job

location

Cities

with greater amenities pay lower wages. Cities with greater cost of living pay higher nominal wages.
Job

security

Jobs

with greater job security pay lower wages.

Prospect
Jobs

of wage advancement

with greater wage advancement have lower starting wages.


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Compensating Differentials
Extent
Jobs

of control over the work place

with less personal control over the workplace and less flexible work hours pay higher wages.

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Differing Skill Requirements

Jobs that require more education and training will pay a higher wage rate than those that do not.
The

wage difference between skilled and unskilled workers is called the skill differential.

Skill differentials can increase, decrease, or reverse wage differences caused by compensating differentials.
Example:

Nurses earn more than ditch

diggers
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Efficiency Wage Payments

Shirking model
Firms

will pay above-market wages where it is costly to monitor employee performance or the employers cost of poor performance is high. will pay above-market wages when hiring and training costs are high. is mixed empirical evidence.
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Turnover model
Firms

Empirical evidence
There

Other Job or Employer Heterogeneities

Union status
Union

workers earn more than nonunion workers.


Most

of the differential is an economic rent to union workers.

Discrimination
Discrimination

against women and minorities exists in some markets and creates wage differentials.

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Other Job or Employer Heterogeneities

Firm size
Large

firms pay higher wages than small firms.


Large

firms are more likely to be unionized. Workers at large firms may be more productive
Training, better workers, greater capital
Higher

wages may be a compensating wage differential.

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4. Wage Differentials: Heterogenous Workers

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NonCompeting Groups

Individuals differ in the type, amount, and quality of their human capital.
The

result is the labor force consists of noncompeting groups of workers that are not easily substitutable for each other. In the short run, these differences in human capital generate wage differentials. In the long run, the wage differentials cause individuals to move to higher paying jobs to some extent.
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Differing Preferences

Differences in time preferences


Persons

who are presented-oriented (i.e., have a high discount rate) are not willing to sacrifice present consumption without a large increase in future income. Persons who are future-oriented (i.e., have a high discount rate) are willing to sacrifice present consumption for a small increase in future income. Persons with lower discount rates acquire more human capital and thus create wage differentials.
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Differing Prefences

Differences in tastes for nonwage aspects of jobs


People

have different preferences for job security, location, and risk. These differences in preferences create wage differentials

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Married vs Single Males


Married males earn 8 to 40% more than single males. Possible explanations:
Differing

personal attributes.

Characteristics

such as personality and reliability enhance the probability of being married and also increase ones wage.

Greater

incentive to acquire human


to help support a family
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capital.
Need

Married vs Single Males


Lower

cost to acquire human capital.

Face

a lower interest rate and wives can help finance education.

Mixed evidence
One

study finds that marriage makes men more productive.


The

marriage premium grows with years married.

Other

studies find that differing personal attributes explain the wage differential.
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Questions for Thought:


1. Discuss: Many of the lowest-paid people in the societyfor example, short-order cooks also have relatively poor working conditions. Hence, the theory of compensating wage differentials is disproved. 2. Explain why pay comparability legislation requiring that the public sector remunerate government employees at wages equal to privatesector counterparts might create excess supplies of labor in public-sector labor markets.

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5. The Hedonic Theory of Wages

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Indifference Map
The hedonic indifference map is composed of a number of indifference curves. Each individual curve shows the various combinations of wage rates and a particular nonwage amenity (for example job safety) that yield a specific level of total utility. Each curve to the northeast reflects a higher level of total utility. A steep curve implies that the person is risk averseit takes a large increase in the wage rate to compensate for a small reduction in job safety. Wage Rate

I1

I2

I3

Nonwage amenity (job safety)

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Isoprofit Curve
The employers isoprofit curve shows the various combinations Wage Rate of wage rates and a particular nonwage amenity (for example job safety) that yield a given level of total profit. The isoprofit curve gets steeper with higher levels of job safety since it gets more and more expensive to increase job safety. Competition among firms will result in only normal profits (zero economic profit) in the long run. Firms will have to make their wage rate-job amenity decisions along a curve such as P. Firms differ in their ability to increase job safety and thus have different isoprofit curves.
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Nonwage amenity (job safety)

Matching
The slope of isoprofit curve PA is less steep than curve PB,which implies the marginal cost of job Wage Rate safety is more expensive at firm B than at firm A. Indifference curve IA is steeper WB than curve IB which implies that person A is more risk averse than person B. Workers maximize utility by WA being tangent to the highest possible isoprofit curve. The risk averse worker will work for the firm able to raise safety at low marginal cost. The worker will get wage WA and safety SA. The risk loving worker will work for the firm able to raise safety at high marginal cost. The worker will get wage WB and safety SB.
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IB
A

PB
IA PA SB SA
Nonwage amenity (job safety)

Labor Market Implications


Workers with fewer nonwage amenities will get higher wages. Laws with minimum safety standards may reduce utility of some workers.
Risk

loving workers would prefer higher wages to greater safety.

Part of the male-female wage differential may reflect differences in preferences for nonwage amenities.
Women

may prefer shorter commuting distances and safer jobs.


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Labor Market Implications

Workers with strong preferences for fringe benefits will match up with firms that can provide fringe benefits at low cost.
Cafeteria

plans which allow workers to choose from a variety of fringe benefits allow workers to get higher utility since they are not forced to accept a fixed bundle.

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6. Wage Differentials: Labor Market Imperfections

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Wage Rate Distributions


If information and job search is costly, then a single equilibrium wage for a specific occupation is not likely to occur. A range of possible wages will exist for an occupation. In this example, 20 percent of workers will earn between $6.80 and $6.99 per hour. However, 5% of the workers will earn between $6.00 and $6.19, while another 5% will earn between $7.60 and $7.79. These wage differentials will not cause job switching since the expected marginal benefits of the higher wage are exceeded by the expected marginal cost of obtaining the information.
25% 20% 15% 12% 10% 5% 0% Wage Rate
6.0 6.2 6.4 6.6 6.8 7.0 7.2 7.4 7.6

20% 15% 15% 12% 8% 5%

8% 5%

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Lengthy Adjustment Period An increase in labor demand


initially may cause a substantial wage increase to W0 in occupations with lengthy training periods. But the supply response to higher wage may create surplus of labor to the occupation in the next period, driving the wage rate lower to W1. For a time the wage rate may oscillate above and below the long-run equilibrium wage rate We before equilibrium in the market is finally restored. During the transition periods, wage differentials between this occupation and others paying We will be observed.

Wage Rate
W0 W2 We W1 W3

We

Units of Time
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Immobilities

Labor immobilities are impediments to the movement of labor and can cause wage differentials. Geographic immobilties
Costs

to moving can deter migration and thus permit wage differentials to exist across geographic areas. on mobility imposed by the government or unions can deter mobility.
Occupational

Institutional immobilties
Restrictions

licensing, apprenticeships

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Immobilities

Sociological immobilties
Race

and gender discrimination will cause racial and gender wage differentials to exist.

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Questions for Thought:


1. Suppose that (a) employees must pay higher wages to attract workers from wider geographic areas and hence higher wages are associated with longer commuting distances (less of the amenity closeness of job to home) and (b) females have greater tastes for having jobs close to their homes than males. Use the hedonic wage model to show graphically why a male-female wage differential might emerge, independently of skill differences or gender discrimination.

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Thank you

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