Economics NINTH EDITION Chapter 32 Insert Cover Picture The Labor Market and The Distribution of Income Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved Learning Objectives 32.1 Explain why competition generates wages equal to marginal revenue product 32.2 Explain why an increase in the wage could increase, decrease, or not change hours worked 32.3 Explain why wages differ across occupations and levels of human capital 32.4 Describe recent changes in the distribution of income 32.5 Describe the effects of government policies on poverty and the distribution of income Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 32.1 THE DEMAND FOR LABOR (1 of 8) Labor Demand by an Individual Firm in the Short Run MARGINAL PRINCIPLE Increase the level of an activity as long as its marginal benefit exceeds its marginal cost Choose the level at which the marginal benefit equals the marginal cost The firm will pick the quantity of labor at which the marginal benefit of labor equals the marginal cost of labor Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 32.1 THE DEMAND FOR LABOR (2 of 8) Labor Demand by an Individual Firm in the Short Run TABLE 32.1 Using the Marginal Principle to make a Lobor Decision (1) (2) (3) (4) (5) (6) Workers Balls Marginal Price Marginal Revenue Marginal Cost Product of Labour (MRP) When Wage = $8 Product of Labour 26 26 $0.50 $13 $8 50 24 0.50 12 72 22 0.50 11 92 20 0.50 10 108 16 0.50 8 120 12 0.50 128 0.50 8 130 0.50 PRINCIPLE OF DIMINISHING RETURNS Suppose output is produced with two or more inputs and we increase one input while holding the other input or inputs fixed Beyond some point— called the point of diminishing returns —output will increase at a decreasing rate Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 32.1 THE DEMAND FOR LABOR (3 of 8) Labor Demand by an Individual Firm in the Short Run Marginal product of labor The change in output from one additional unit of labor Marginal-revenue product of labor (MRP) The extra revenue generated from one additional unit of labor; MRP is equal to the price of output times the marginal product of labor Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 32.1 THE DEMAND FOR LABOR (4 of 8) Labor Demand by an Individual Firm in the Short Run Using the marginal principle, the firm picks the quantity of workers at which the marginal benefit (the marginal revenue product of labor) equals the marginal cost (the wage) The firm’s short-run demand curve for labor is the marginal revenue product curve Short-run demand curve for labor A curve showing the relationship between the wage and the quantity of labor demanded over the short run, when the firm cannot change its production facility Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 32.1 THE DEMAND FOR LABOR (5 of 8) Labor Demand by an Individual Firm in the Short Run An increase in the price of the good produced by workers increases the marginal revenue product at each quantity of workers, shifting the demand curve to the right At each wage, the firm will demand more workers For example, at a wage of $8, the demand for labor increases from five workers (point b) to seven workers (point d) Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 32.1 THE DEMAND FOR LABOR (6 of 8) Market Demand for Labor in the Short Run To draw the short-run market demand curve for labor, we add the labor demands of all the firms that use a particular type of labor If there were 100 firms and each hired workers at a wage of $8, the market demand for labor would be 500 workers Similarly, if the typical firm hired workers at a wage of $11, the market demand would be 300 workers Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 32.1 THE DEMAND FOR LABOR (7 of 8) Labor Demand in the Long Run Long-run demand curve for labor A curve showing the relationship between the wage and the quantity of labor demanded over the long run, when the number of firms in the market can change and firms can modify their production facilities Output effect The change in the quantity of labor demanded resulting from a change in the quantity of output produced Input-substitution effect The change in the quantity of labor demanded resulting from an increase in the price of labor relative to the price of other inputs Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 32.1 THE DEMAND FOR LABOR (8 of 8) Labor Demand in the Long Run In less-developed countries, labor is less costly relative to machinery and equipment, so labor is substituted for these other inputs Examples: Mining Firms in some less-developed countries use thousands of workers digging by hand Furniture Firms in some less-developed countries make furniture by hand Accounting Some accountants in less-developed countries use simple calculators and ledger paper Short-Run versus Long-Run Demand There is less flexibility in the short run because firms cannot enter or leave the market and they cannot modify their production facilities As a result, the demand for labor is less elastic in the short run That means the short-run demand curve is steeper than the long-run demand curve Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 32.3 LABOR MARKET EQUILIBRIUM (4 of 9) Why Do Wages Differ Across Occupations? The supply of workers in a particular occupation could be small for four reasons: Few people with the required skills High training costs Undesirable working conditions Danger Artificial barriers to entry Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 32.3 LABOR MARKET EQUILIBRIUM (5 of 9) Why Do Wages Differ Across Occupations? If supply is low relative to demand—because few people have the skills, training costs are high, or the job is undesirable—the equilibrium wage will be high Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 32.3 LABOR MARKET EQUILIBRIUM (6 of 9) The Gender Pay Gap A recent study explored several factors that contribute to the gender pay gap The study observed a gap of about 20 percent among workers aged 26 to 34, and identified four factors that contribute to the gender gap: • Difference in worker skills and productivity • Differences in occupational preferences • Occupational discrimination • Wage discrimination Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 32.3 LABOR MARKET EQUILIBRIUM (7 of 9) Racial Discrimination African American males who work full time earned 73 percent as much as their white counterparts, while African American females earn 85 percent as much as their white counterparts Hispanic males earn 65 percent as much as white males, while Hispanic females earn 78 percent as much as white females For both males and females, part of the earnings gap is caused by differences in productivity: On average, whites have more education and work experience, so they are paid higher wages However, part of the wage gap is caused by racial discrimination Earnings differences have decreased over the last few decades Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 32.3 LABOR MARKET EQUILIBRIUM (8 of 9) Why Do College Graduates Earn Higher Wages? In 2009, the college premium—the increase in earnings from a college degree—was 74 percent Learning effect The increase in a person’s wage resulting from the learning of skills required for certain occupations Signaling effect The information about a person’s work skills conveyed by completing college Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 32.3 LABOR MARKET EQUILIBRIUM (9 of 9) Labor Unions and Wages Labor union A group of workers organized to increase job security, improve working conditions, and increase wages and fringe benefits Featherbedding Work rules that increase the amount of labor required to produce a given quantity of output Featherbedding may actually decrease the demand for labor Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved APPLICATION THE BEAUTY PREMIUM APPLYING THE CONCEPTS #3: What explains differences in wages? How does physical attractiveness affect earnings? Studies of the U.S labor market show that beautiful people earn more than people of average books, and unattractive people earn less The beauty premium is percent for the 33 percent of workers who are considered beautiful or handsome, and the beauty premium is larger for men than for women The penalty for bad looks is about percent for the 10 percent of workers who are considered plain or unattractive Why beautiful people earn more income? According to biologists, beauty is a marker for underlying characteristics such as health and intelligence, and beautiful people start with a slight edge in the labor market Beautiful people get more opportunities to learn through experience, and they also acquire better professional contacts Because of these wider opportunities, a small difference in innate characteristics can be amplified into a large difference in earnings Another factor in the beauty premium is that some workers and consumers simply like dealing with attractive people, so there is a higher demand for beautiful workers, resulting in higher wages Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 32.4 THE DISTRIBUTION OF INCOME (1 of 2) Income Distribution in 2007 To compute the numbers in the second column of the table (Percent of Market Income), we take four steps: Rank the nation’s households according to market income Divide the households into five groups, or “quintiles.” Compute each group’s income Compute each group’s share of market income TABLE 32.2 Distribution of Market Income, 1979-2007 Group Share of Market Share of Market Percentage growth in Income, 1979 Income, 2007 income, 1979-2007 Quintile (percentiles 0-20) 2.9 2.5 18.3 Quintile (percentiles 20-40) 10.1 7.3 27.5 Quintile (percentiles 40-60) 15.3 12.2 35.2 Quintile (percentiles 60-80) 22.4 19.0 43.3 Quintile (percentiles 80-100) 49.6 59.9 75.6 Percentiles 80-99 39.1 38.6 65.0 Top Percent 10.5 21.3 277.5 Source: Congressional Budget Office, Trends in the Distribution of Household Income between 1979 and 2007 (Washington, DC,2011) Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 32.4 THE DISTRIBUTION OF INCOME (2 of 2) Income Distribution Facts Three key factors explain these substantial differences in market income: Differences in labor skills and effort Luck and misfortune Discrimination Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved APPLICATION TRADE-OFFS FROM IMMIGRATION APPLYING THE CONCEPTS #4: Who benefits from immigration of low skill workers? In the first wave of immigration, from 1850 to 1913, over a million people migrated to the Americas each year Most were from European countries After decades of war and depressions, immigration resumed in 1945, and most of the immigrants were from less-developed countries The most recent wave of immigration started in 1990 and has increased the supply of labor to the U.S economy by about 10 percent per decade Immigration creates winners and losers within the economy The increase in the supply of labor decreases wages for workers who have the same skill level as the immigrants Because the average U.S immigrant has less education and earns less income than the average native, immigrants compete with low-skill natives, decreasing their wages On the benefit side, the decrease in the wages of low-skill labor decreases production costs and product prices, so consumers benefit In general, we expect low-skill workers to lose as a result of immigration because the lower wages will dominate the benefits of lower consumer prices In contrast, we expect high-skill workers to benefit from lower prices Economists have estimated the net effect of immigration on the U.S economy is a small positive effect Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 32.5 PUBLIC POLICY AND THE DISTRIBUTION OF INCOME (1 of 3) EFFECTS OF TAX AND TRANSFER POLICIES ON THE DISTRIBUTION OF INCOME TABLE 32.3 Government Policies and the Distribution of Income Group Share of Market Income, 2007 Share of Income After Federal Tax and Change in Share from Federal Tax and Transfers, 2007 Transfers Quintile (percentiles 0-20) 2.5 5.1 +2.6 Quintile (percentiles 20-40) 7.3 9.2 +1.9 Quintile (percentiles 40-60) 12.2 14.0 +1.8 Quintile (percentiles 60-80) 19.0 19.9 +0.9 Quintile (percentiles 80-100) 59.9 52.7 -7.2 Percentiles 80-99 38.6 35.6 -3.0 Top Percent 21.3 17.1 -4.2 Source: Congressional Budget Office, Trends in the Distribution of Household Income between 1979 and 2007 (Washington, DC,2011) Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 32.5 PUBLIC POLICY AND THE DISTRIBUTION OF INCOME (2 of 3) Poverty and Public Policy TABLE 32.4 Poverty Rates For Different Groups, 2010 Characteristic All Races Poverty Rate in 2010 15.2% White 13.1 Black 27.5 Hispanic 26.7 Asian 12.1 Type of Family Married couple 7.6 Female-headed household 28.7 Age Under 18 years 22.5 65 years and older 9.0 SOURCE: U.S Census Bureau, Current Population Reports: Report P60-241 (November 2011) Poverty rates vary by: Race Type of family Age Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 32.5 PUBLIC POLICY AND THE DISTRIBUTION OF INCOME (3 of 3) The Earned Income Tax Credit EITC is an earnings subsidy for low-income households that is determined by the number of children in the household Here is how the EITC works for a household with two children (roughly two fifths of EITC recipients) Phase in: For the first $12,590 of earnings, the subsidy rate is 0.40: for each $1 of earnings, the government provides a subsidy of $0.40 Flat spot: The credit reaches its maximum of $5,036, when household earnings reaches $12,590 For the next $2,410 of income, the credit remains at the maximum Phase out For income above $15,000, the phase-out rate is 0.21: for each additional dollar of earnings, the credit decreases by $0.21 The earnings subsidy reaches zero at an income of $40,363 Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved APPLICATION EXPANDING THE EITC APPLYING THE CONCEPTS #5: How government policies affect the distribution of income? In response to stagnant wages for low-income workers, policy-makers have proposed the expansion of wage subsidy programs Under the President’s 2014 plan, EITC coverage would increase payments to 7.7 million workers and extend coverage to 5.8 million additional workers Most of the additional workers are either young (age 21-24) or old (age 65-67) and not have qualifying children The expansion of EITC would lift about half a million people above the poverty line and reduce poverty of an additional 10 million workers It might also increase labor force participation Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved KEY TERMS Income effect for leisure demand Input-substitution effect Learning effect Long-run demand curve for labor Marginal product of labor Marginal-revenue product of labor (MRP) Market supply curve for labor Means-tested programs Output effect Short-run demand curve for labor Signaling effect Substitution effect for leisure demand Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved ... Reserved 32. 1 THE DEMAND FOR LABOR (7 of 8) Labor Demand in the Long Run Long-run demand curve for labor A curve showing the relationship between the wage and the quantity of labor demanded over... thousands of workers digging by hand Furniture Firms in some less-developed countries make furniture by hand Accounting Some accountants in less-developed countries use simple calculators and. .. Inc All Rights Reserved 32. 1 THE DEMAND FOR LABOR (6 of 8) Market Demand for Labor in the Short Run To draw the short-run market demand curve for labor, we add the labor demands of all the firms