Earnings and Discrimination
Microeonomics
P R I N C I P L E S O F
N. Gregory Mankiw
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In this chapter,
look for the answers to these questions:
How do wages compensate for differences in job characteristics?
Why do people with more education earn higher wages?
Why are wages sometimes above their equilibrium values?
Why is it difficult to measure discrimination?
When might the market solve the problem of discrimination? When might it not?
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U.S. Median Weekly Earnings, Selected Occupations, 2006
n.e.d. = not enough data for BLS disclosure requirements
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Introduction
In competitive markets, the wages workers earn equal the value of their marginal products.
There are many factors that affect productivity and wages…

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Compensating Differentials
Compensating differential: a difference in wages that arises to offset the nonmonetary characteristics of different jobs
These characteristics include unpleasantness, difficulty, safety. Examples:
Coal miners and fire fighters are paid more
than other workers with similar education
to compensate them for the extra risks.
Night shift workers paid more than day shift
to compensate for the lifestyle disruption of working at night.

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Ability, Effort, and Chance
Greater ability or effort often command higher pay. These traits increase workers’ marginal products, make them more valuable to the firm.
Wages also affected by chance
E.g., new discoveries no one could have predicted make some occupations obsolete, increase demand in others

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Ability, Effort, and Chance
Ability, effort, and chance are difficult to measure, so it is hard to quantify their effects on wages.
They are probably important, though,
since easily measurable characteristics
(education, age, etc.) account for less than half
of the variation in wages in our economy.

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Case Study: The Benefits of Beauty
Research by Hamermesh and Biddle:
People deemed more attractive than average
earn 5% more than people of average looks.
Average-looking people earn 5-10% more
than below-average looking people.

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Case Study: The Benefits of Beauty
Hypotheses:
1. Good looks matter for productivity
In jobs where appearance is important, attractive workers are more valuable to the firm, command higher pay.
2. Good looks indirectly related to ability
People who make an effort to project attractive appearance may be smarter or more competent in other ways.
3. Discrimination

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The Superstar Phenomenon
Superstars like Will Smith, Bono earn many times more than average in their fields.
The best plumbers or carpenters do not.
Superstars arise in markets that have two characteristics:
Every customer in the market wants to enjoy the good supplied by the best producer.
The good is produced with a technology that allows the best producer to supply every customer at a low cost.

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Human Capital
Human capital: the accumulation of investments in people, such as education and on-the-job training
Human capital affects productivity, and thus labor demand and wages.

Weekly Earnings of Full-Time Employed Persons Age 25+ by Education, 2007:Q4
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The Increasing Value of Skills
Women
Men
Percentage difference in annual earnings for college graduates
vs. high school diploma
The earnings gap between college-educated and
non-college-educated workers has widened in recent decades.

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The Increasing Value of Skills
Two hypotheses:
1. International trade
Rising exports of goods made with skilled labor, rising imports of goods made with unskilled labor.
2. Skill-biased technological change
New technologies have increased demand for skilled workers, reduced demand for unskilled workers.
Difficult to determine which hypothesis
better explains the widening earnings gap;
probably both are important.

Suppose you were offered this choice:
A. Spend 4 years studying at the world’s best university, but must keep your attendance there a secret.
B. Get an official degree from the world’s best university, but cannot actually study there.
Which do you think would enhance your future earnings more?

A C T I V E L E A R N I N G 1
Discussion question
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The Signaling Theory of Education
An alternative view of education:
Firms use education level to sort between
high-ability and low-ability workers.
The difficulty of earning a college degree demonstrates to prospective employers that college graduates are highly capable.
Yet, the education itself has no impact on productivity or skills.
Policy implication: Increasing general educational attainment would not affect wages.

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Reasons for Above-Equilibrium Wages
1. Minimum wage laws
The minimum wage may exceed the eq’m wage of the least-skilled and experienced workers
2. Unions
Union: a worker association that bargains with employers over wages and working conditions
Unions use their market power to obtain higher wages; most union workers earn 10-20% more than similar nonunion workers.

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Reasons for Above-Equilibrium Wages
3. Efficiency wages
Efficiency wages: above-equilibrium wages paid by firms to increase worker productivity
Firms may pay higher wages to reduce turnover, increase worker effort, or attract higher-quality job applicants.

In each case, identify which worker would earn more and explain why.
A. The best physical therapist on the planet or
the best writer on the planet
B. A trucker that hauls produce or a trucker that hauls hazardous waste from nuclear power plants
C. A graduate of an Ivy League college or an equally intelligent & capable graduate of a state university
D. Someone who graduated from a state university with a 3.7 GPA, or someone who graduated from the same university with a 2.4 GPA
A C T I V E L E A R N I N G 2
Explaining wage differentials
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A. The best physical therapist on the planet or
the best writer on the planet
The superstar phenomenon:
The best writer can service many more customers than the best physical therapist.
B. A trucker that hauls produce or a trucker that hauls hazardous waste from nuclear power plants
Compensating differentials:
The hazardous waste hauler earns more to compensate for the higher risks.
A C T I V E L E A R N I N G 2
Answers
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C. A graduate of an Ivy League college or an equally intelligent & capable graduate of a state university
The signaling theory of education:
Employers assume the Ivy League grad has more ability than the state university grad.
D. Someone who graduated from a state university with a 3.7 GPA, or someone who graduated from the same university with a 2.4 GPA
The human capital theory of education:
A higher GPA reflects greater learning, which leads to higher productivity and wages.
A C T I V E L E A R N I N G 2
Answers
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The Economics of Discrimination
Discrimination: the offering of different opportunities to similar individuals who differ only by race, ethnicity, gender, or other personal characteristics

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Measuring Labor-Market Discrimination
Median earnings of full-time U.S. workers, 2007:
White males earn 21% more than white females.
White males earn 24% more than black males.
Taken at face value, these differences look like evidence that employers discriminate.
But there are many possible explanations for wage differences besides discrimination; the data above do not control for differences in other factors that affect wages.

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Measuring Labor-Market Discrimination
Differences in human capital among groups:
White males 75% more likely to have college degree than black males
White males 11% more likely to have graduate degree than white females
Women have less on-the-job experience than men
Public schools in many predominantly black areas are of lower quality (e.g., funding, class sizes)
There may well be discrimination in access to education, but this problem occurs long before workers enter the labor force.

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Measuring Labor-Market Discrimination
Recent study by Bertrand and Mullainathan finds evidence of labor-market discrimination:
5000 fake résumés sent in response to
“help wanted” ads.
Half had names more common among blacks,
like Lakisha Washington or Jamal Jones.
The other half had names common among whites, like Emily Walsh or Greg Baker.
Otherwise, the résumés were the same.
The white names received 50% more calls from interested employers than the black names.

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Discrimination by Employers
Competitive markets provide a natural remedy for employer discrimination:
The profit motive…

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The non-discriminating firms can hire females for a lower wage, giving them a cost advantage and economic profits, which attract entry of other non-discriminating firms.
Suppose some firms discriminate against female workers. They will hire fewer females, more males.
Result: A wage differential.
The discriminating firms will begin to lose money and be driven out of the market.
Result: Demand for female workers increases,
demand for male workers falls until wages are equalized.
Discrimination by Employers
Male workers
Female workers

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Discrimination by Consumers
Discrimination by consumers may result in discriminatory wage differentials.
Suppose firms care only about maximizing profits, but customers prefer being served by whites.
Then firms have an incentive to hire white workers, even if non-whites are willing to work for lower wages.

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Discrimination by Governments
Some government policies mandate discriminatory practices.
apartheid in South Africa before 1994
early 20th century U.S. laws requiring segregation in buses and streetcars
Such policies prevent the market from correcting discriminatory wage differentials.

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CONCLUSION
In competitive markets, workers are paid a wage that equals the value of their marginal products.
Many factors affect the value of marginal products and equilibrium wages.
The profit motive can correct discrimination by employers, but not discrimination by customers or discriminatory policies of governments.
Even without discrimination, the distribution of income may not be equitable or desirable –
a topic we explore in the following chapter.

CHAPTER SUMMARY
Other things equal, wage differences compensate workers for job attributes: The harder or less pleasant a job, the more a worker is compensated.
Workers with more human capital are more productive and command higher wages than workers with less human capital.
Workers with college degrees may get better job offers because the degree signals high natural ability to employers.
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CHAPTER SUMMARY
Wages also may differ with natural ability, effort, and chance.
Wages are sometimes above their equilibrium levels, due to minimum wage laws, the market power of labor unions, and efficiency wages.
Some differences in earnings are due to discrimination on the basis of race or other characteristics. Measuring the amount of discrimination is difficult, though.
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CHAPTER SUMMARY
The profit motive tends to limit the impact of employer discrimination on wages.
Discrimination by consumers or governments may lead to persisting wage differentials.
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