Economics - Headway

 Standard 7 - Resource markets and financial markets determine wages, interest rates and commodity prices.

Benchmark - 9.2.4.7.1 - Explain the role of productivity, human capital, unions, demographics and government policies in determining wage rates and income in labor markets.

          

INTRODUCTION
The purpose of this lesson is to establish how wages are reached
in markets which are in perfect competition as well as in
markets where a monopsony is present. Union strategies are
categorized, and the special case of bilateral monopoly is
studied. Wage differentials are explained. The role of human
capital is analyzed.

WAGE
Wage includes all forms of remuneration for all human
productive activities using one's skills. Thus, wage is the
combination of salary, bonus and other forms of
compensation. Wage is paid for work as various as that of a
blue-collar mechanic, as well as that of a lawyer. The dollar
amount received is referred to as nominal wage. The purchasing
power of amount received work is real wage.

In economics, wage is a general term. For instance, the work performed by a medical doctor may result in a fee, and various other names are used for different professions. For economists, the different types of work do not matter: it is all labor, and the price or payment is wage.

REAL WAGE
The dollar amount received for an hour's work is referred to
as nominal wage. Real wage is the nominal wage adjusted for
inflation. It is calculated by dividing the dollar amount by
one plus the rate of inflation. The rate of change in unit labor cost is equal to
the rate of change in real wage less the rate of change in
productivity. Thus unit labor cost does not increase as long as
the rate of growth of real wage is just equal to the growth of
productivity.

What a salary can buy in terms of various goods and services is real wage. It is only used as a comparison to some prior time period. The consumer price index is often used as the rate of inflation.

PRODUCTIVITY
The higher productivity of labor is the major explanation of
higher wages. This is true for the higher wage and productivity
of American workers. Their higher productivity is attributable
to 1) large capital, 2) advanced technology, 3) skills and
education, and 4) motivation and culture.

American workers are highly paid because of their productivity. This can be observed in agriculture: using combines on large fields, American farmers are able to produce some of the highest output per man-hour in the world.

PRODUCTIVITY DECLINE
The advantage of the American worker's higher productivity,
which has been experienced in the past, is recently eroding.
Some of the reasons for the decline are tied to slower rate of
capital formation and technological progress, as well as
erosion in education.

Loss of competitiveness of American products has recently received much publicity. While it is true that we are importing an increasing number of products, it is an indication of the prosperity of the American economy as well as the ingenuity and motivation of the people of several nations (such as Japan and Korea). There are also purely monetary reasons for the U.S. trade deficit.

WAGE DETERMINATION
The wage paid by an employer is given by the supply curve
at the optimum level of labor for the firm. The optimum
quantity of labor is determined first. This is established by
the equality MRC=MRP (marginal resource cost equals marginal
revenue product) in both competitive and monopsonistic markets.
But the wage determination itself is different in the two types
of markets.

 

All businesses determine their need for additional employees on the basis of what they want to produce or sell. Finding the wage is a two step process: first the number of employees is calculated, then the firm knows what it can afford to pay an additional employee.

WAGE DETERMINATION IN PERFECT COMPETITION
Perfect competition in a resource market means that there are
many small buyers of the resource, and that none can influence
the market. The supply curve is identical to the marginal
resource cost curve (MRC), and is horizontal. The wage is given
directly by the intersection of the supply line and MRP curve
(which is the demand for labor).

Take clerical work, for instance. All businesses need someone to do typing, filing and keeping records. Many potential employees are available. There is no need for the firm to offer a higher wage than the currently prevailing wage for that type of work. Nor should the firm offer less, because if it did, it would find no one willing to work.

WAGE DETERMINATION IN MONOPSONY
A firm has a monopsonistic power when it is able to pay a lower
price for a larger quantity of a resource used. A monopsony
typically exists when a firm is the sole employer in a region
or a profession. For a monopsony, the marginal resource cost
curve is above the supply curve. The optimum quantity of labor
is determined by the intersection of MRC and MRP. The wage is
obtained by extending that quantity level down to the supply
curve.

 

The news media has reported instances where employees have complained of being underpaid as a result of a company being the dominant or only employer in a town. For instance, such reports appeared about the General Electric, Hormel (a meat packaging plant) and WestPoint-Pepperel (textile manufacturer) in the United-States. In each of these cases, the employer is able to offer a lower wage because local residents have little choice but to work for that employer.

WAGE DETERMINATION IN MONOPSONY
The wage paid by a monopsony is lower than the wage paid by
firms in perfect competition in the labor market. In addition,
the quantity of labor used is also smaller.

UNION STRATEGY
Unions seek to improve the wages and working conditions of
their members; this can be accomplished by
- increasing the demand for the product manufactured by the
members (for instance, by discouraging imports),
- decreasing the supply of labor (e.g. craft unions),
- acquiring power over all employees (e.g. industrial unions).

The American union IGLWU (International Ladies Garment Workers Union) periodically used advertisement to encourage purchases of American made garments. The purpose is obviously to boost the sales of the clothing made by their members and therefore their salaries.

BILATERAL MONOPOLY
A bilateral monopoly exists when a monopsonist (a dominant
employer) faces a monopolist (an all inclusive union). The
employer will offer the monopsonist lower wage Wm (given by the
intersection of MRP and the supply curve). The union will demand from the monopolist a higher
wage Wu (determined by the intersection of MRC and the demand
curve). The disparity between the two can only be resolved by
external power: this explains lasting bitter strikes and other labor
conflicts.

The use of violence in strikes by both, strikers and the
company, can be explained by the analysis of bilateral monopoly.
The demands of the union and the offer of the employer are
irreconcilable in economic terms. To prevail, each side has to
revert to means other than economic.

MINIMUM WAGE
The minimum wage is necessary to avoid hardship and poverty of
low skilled individuals. The minimum wage (as any minimum price)
has contributed to a surplus of the labor resource: that is,
unemployment. However, some additional positive effects are
argued to exist: such as
- forcing employers to be more efficient
- encouraging automation and providing employees with such means
- forcing employers to improve workers' skills and health

Small business owners, especially store owners, often complain that they cannot afford to hire employees at the minimum wage, and that, if the minimum wage were to be lifted, there would be less unemployment.

WAGE DIFFERENTIALS
Differences between wages are explained by
- different levels of skills and education,
- non-monetary aspects such as risk and seasonality,
- market imperfections: lack of knowledge,
lack of geographical and socio-economic mobility.

It is rather obvious that a medical doctor would receive a high salary because of his/her knowledge and skills. High salaries of workers in construction or on oil rigs can be explained by the very real hazard these occupations present for workers' safety.

HUMAN CAPITAL
Human capital refers to the investment individuals make in their
education and health, as well as to their attributes (skills,
knowledge) which make them better employees. Statistical
studies clearly show a direct relationship existing between
education and income levels. The causal explanation of the
relationship has, however, been challenged by the observation
that the level of education is primarily determined by
socio-economic group belonging.

Studies show that some groups in society inculcate their children with a need to achieve. These groups are often the new immigrants in a nation. An example of this can be observed in the number of Westinghouse Science High School awards given to children of newly arrived Asian groups: that number is much higher than that for the general population.

PRODUCTIVITY AND REAL WAGES
According to Department of Labor studies, a close relationship
exists between real wages and productivity. Real wages generally
do not rise unless productivity increases. An increase in output
will translate into increased real income. Increased productivity
causes the demand for labor to increase in relation to
supply, which in turn causes real wages to increase. Increased
productivity in the United States has been largely responsible
for higher real incomes.

 

 

Quiz on the Content:

 

A.  Identify the factors which explain the high pay of U.S.
workers. Give reasons for the recent decline in productivity.

B.  Distinguish between the different types of strategies of
unions.

C.  Discuss the difficulty of conflict resolution in a bilateral
monopoly.

 D. 
Identify the reasons for wage differentials.

E.  Define human capital and list its various forms. Show its
importance for higher wages, and present a critique of that
argument.

F.  What role has management in the United States played in
productivity growth? What indirect factors have also influenced
the productivity of the United States?