Lecture Notes: Nov. 25

Econ. 103, Fall 2002, Prof. Nancy Folbre

human capital theory

labor market discrimination

labor unions

winner-take-all markets

compensating wage differentials

comparable worth

Assignment 7: Due in discussion section next week (postponed a week). From Ch. 12, # 1, # 3. From Ch. 13, #2, #7. Short thought piece: Many of the jobs that women choose to enter pay less than the jobs than men choose to enter (same pattern applies to choice of college majors). What explains these choices? Is this pattern likely to change?

12.3--a recap of some themes in the economics of information. Workers who help facilitate trades by providing additional information can be just as productive as workers who produce physical goods, because they help produce economic surplus.

Carlos is risk-neutral and has an ancient farmhouse with great character for sale in Slaterville Springs. His reservation price for the house is $130,000. The only possible local buyer is Whitney, whose reservation price for the house is $150,000. The only other houses on the market are modern ranch houses that sell for $125,000, which is exactly equal to each potential buyer's reservation price for such a house. Suppose that if Carlos does not hire a realtor, Whitney will learn from her neighbor that Carlos' house is for sale, and will buy it for $140,000. However, if Carlos hires a realtor, he knows that the realtor will put him in touch with an enthusiast for old farmhouses who is willing to pay up to $300,000 for the house. Carlos also knows that if he and this person negotiate, they will agree on a price of $250,000. If realtors charge a commission of 5% of the selling price and all realtors have opportunity costs of $2,000 for negotiating a sale, will Carlos hire a realtor? If so, how will total economic surplus be affected?

A hint to get started: Carlos compares the price he would get without a realtor to the price he would get with a realtor $140,000 compared to 250,000 minus .05(250,000).

The surplus he gets is the difference between his reservation price ((140,000) and the price he is paid). Similarly, the surplus for others is the difference between their reservation price (or their opportunity cost) and what they get. Total surplus is the sum of all those surpluses.

In a competitive labor market, the equilibrium wage is determined by the intersection of the demand for labor and the supply of labor. A number of outside facts can shift the supply or demand in ways that affect wages--independently of the capabilities of individual workers or their willingness to work.

Individual firms don't choose what to pay their workers; they have to pay the prevailing market wage. In deciding how many workers to hire, they compare the wage they have to pay with the contribution an additional worker would make to their total revenue--the marginal revenue product.

13.2

Stone, Inc., owns a clothing factory and hires workers in a competitive labor market to cut and sew denim fabric into jeans. The fabric required to make each pair of jeans costs $5. The company's weekly output of finished jeans varies with the number of workers hired, as shown in the following table:

a. If the jeans sell for $35/pair and the competitive market wage is $250 per week, how many workers should Stone hire? How many pairs of jeans will the company produce each week?

to get started on this question, calculate the marginal product for each product, and then the value of the marginal product (multiplying the marginal product times the price of the product). Fill those in for each of the possible number of workers on each row and the answers become obvious.

Now, back into the substance of the chapter.

Human capital is what you are. A carbon-based life form with impressive productive capabilities. Intelligence and flexibility. What distinguishes you from other pieces of capital equipment is that you cannot be bought and sold (that would be slavery). But you can be rented or leased. When an employer hires you, he or she is renting your productive capabilities by paying you a wage plus benefits.Your productive capability consists of all of the productive capabilities you have that might increase your future earnings. Indeed, your economic value today is the present value of all your future earnings. In this context, your present value is what you would have to put into the bank today at a given interest rate in order to generate the same flow of income. Let's say you plan on earning $40,000 a year when you graduate at age 22, and you will receive the same wages every year until you retire at age 72. Assume that the interest rate over that period will average about 5%. How much money would you need to put into the bank to get the same amount of income? Let that amount of money be represented by PV (for present value). (PV (.05)=40,000 ; 40,000/.05=$800,000. You will generate about the same income as about $800,000 put into the bank over that period. (This is a slight variation of the formula on p. 210 of your text). Note that this measure of your value would be taken into account if your family was being compensated for a wrongful death or you were one of the casualties of 9/11).

Studies show that both education and labor force experience have a significant effect on the rate of return to human capital. College-educated workers earn significantly more than others. If you have adequate information, you can often calculate the potential benefits of more education. See the section in the text on p. 330, "Should Betsy get an MBA?" Betsy estimates that getting an MBA will increase the present value of her lifetime earnings by $43,000. The cost of the tuition payments is $42,000. So, the benefits exceed the costs.

Why does education increase your human capital? Because it increases your skills and makes you more productive (but don't forget that an increase in the supply of college educated workers could shift the supply and lower the market wage). Also, because (as aforementioned in discussion of the economics of information, it sends a signal that you know how to show up on time, follow instructions, and fulfill assigned tasks. You are a well-behaved productive unit, as well as a skilled one.

Skill is an interesting concept, that has at least two dimensions. First, there are cognitive skills--which we purport to measure with standardized tests. Second, there are emotional skills, that affect your ability to solve problems by working with other people (e.g., getting help when you need it). A very interesting book by Daniel Goleman, Emotional Intelligence, suggests that these latter skills are actually more important to economic success. But obviously the two kinds of skills work together.

Another aspect of human capital is experience--here again, both productivity and signalling come into play. The kinds of jobs you have had are an indicator of your aspirations and goals. They also represent the kinds of skills you have accumulated on the job. In many careers, people who take time out from paid employment (e.g. to stay home with their kids) pay a significant penalty. Is this because they are less productive, because their skills have "depreciated" while they are at home? Or is it because they are sending a signal that earning money is not their top priority in life? It's very difficult to figure out the answer to this question, but it is a very important one, because differences in labor market experience help explain why women earn substantially less than men over their lifetimes. Women, on average, earn about 75 cents for every dollar men earn. But women who don't marry and don't have children tend to earn about the same as what single men with the same education earn...

Note also that the women who take that time out often end up as single parents, many of them devoting more time and money to kids than than the fathers...so they are paying a disproportionate share of the costs of actually producing the human capital that gets educated in school. This is something that gets left out of conventional economic analysis (there's more discussion of this in The Invisible Heart).

Labor Market Discrimination
Discrimination in the labor market means treating workers unequally even when they have the same productive characteristics (human capital). Since it is hard to precisely measure the latter it is not surprising that it is hard to pin down the former. But there is a long history of rules and laws (plus patterns of inequality) that have revealed explicit discrimination in the past. An interesting method that is often used today to get at discrimination is an "audit" study, which is a variation on a "hidden camera" method. Two workers who are similar in every respect except their gender or race apply for a job, in a context in which the employer does not realize that he or she is being "tested." A variation on this could take the form of a survey in which I hand out a description of a college graduate and ask you to predict what you think that person's future earnings will be. Unbeknownst to you, some of you have a description of a male, others a female; otherwise the characteristics are exactly the same. If you are like others you will be likely to assess the earnings prospects of the male more favorably. Is this because you are biased, or because you are engaging in "statistical discrimination" ? That is, attributing to individuals the characteristics of the "average" person with the same demographic characteristics? Or just "internalizing" the discriminatory attitudes of others? Hard to say.

Discrimination on the basis of race and gender is against the law--but many other forms of discrimination are not. Problem is that it is very hard to prove intent to discriminate--need for a "smoking gun"--indeed, much discrimination may be unconscious, rather than explicit.

Conventional economic theory suggests that discrimination is inefficient--all a perfectly rational employer should care about is the workers' marginal value product. So, an employer who DOES NOT discriminate should have an advantage....because discrimination by others reduces the market wage of the group discriminated against and makes them a really good deal for those who are not encumbered by "irrational" attitudes. Assuming that there are enough non-discriminators to make a difference, their decisions should gradually bid up the price of the discriminated against group (shifting the demand for them to the right) thus eliminating the discriminatory differential....Unfortunately, there's not much evidence that this works in the real world.

Another interesting thing about gender inequality--choices in the labor market affect outcomes in the dating or marriage "market." Men generally benefit both places from choosing well-paying jobs; women are often penalized in the dating/marriage market for choosing jobs that are considered "unfeminine" (and many well-paying jobs fall in this category, especially in the less-educated category).

Labor Unions
Collective bargaining and workers' rights

the decline of trade unions--forcing changes in their strategy

often union members earn more money and get higher benefits

but they are often more productive than other workers as well

raises issue of "high road" versus "low road" strategies

maybe union pressure to increase wages forces employers to be more efficient and benefits everyone?

Technological change, among other factors, contributes to a change in the reward structure...

Instead of every town having a football team and a symphony orchestra we have international competition--so a few very well-paid individuals in sports and music and some who can hardly make a living at them...is this an efficient system? Or do people misperceive their individual probability of winning?

Jobs vary not only in pay but also in non-pecuniary rewards, or what you might call psychic benefits. Presumably, people will demand higher pay to work in jobs that are unpleasant, risky, morally disgusting, etc. and will accept lower pay to work in jobs that are pleasant, safe, and morally uplifting...

e.g. would you rather be a lawyer for the American Cancer Society or for Phillip Morris?

How much more would you demand in wages to work for Phillip Morris?

Women often seem more willing to pay a price for their moral values in this respect than men do (see discussion of this in Invisible Heart).

Women's job preferences --combined with discrimination--seem to explain why they often end up in jobs that pay less than men's jobs (e.g. child care workers earn less than parking lot attendants). Policies of "comparable worth" are designed to set wages that more accurately reflect the demands of the jobs....but of course this interferes with the workings of the market.

Two problems with the market-based approach presented in the text--one is that many large firms set internal pay scales for jobs that are predominantly male and female, so the market doesn't have that much influence, anyway. Cultural norms of gender-appropriate work may thereby be reinforced. The only way to change them is to challenge them.

A second problem is that time and energy devoted to caring jobs such as child care and elder care may generate important social externalities, so that market wages for them are not efficient anyway.