ppa 723: managerial economics lecture 16: input markets the maxwell school, syracuse university...

PPA 723: Managerial Economics

Lecture 16:

Input Markets

The Maxwell School, Syracuse UniversityProfessor John Yinger

Managerial Economics, Lecture 16: Input Markets

Outline

The Basic Analytics of an Input Market

The Labor Market and Income Inequality

Discrimination in Labor Markets


The Labor Market

Supply: The labor-leisure trade-off.

Demand: Firms select the profit-maximizing number of workers to hire at each wage.

Called derived demand because it is derived from the firm’s interest in producing and selling a product.


The Demand for Labor

To maximize profits, the firm keeps hiring more workers until the marginal benefit from another worker equals the marginal cost.

Marginal benefit = amount of the product another worker can produce (MPL) multiplied by the price of the product, P.

Marginal cost = wage rate = w.So (MPL ) (P) = MRPL ( = VMPL ) = w.


Hiring by a Public or Non-Profit Manager

The decision rule that firms use, namely, hire until MRPL, = w, provides the intuition for public and non-profit hiring:

Hire until the value of another workers contribution to the goals of the agency equals the cost of hiring him or her.

But the rule is of little formal use, since the goals of the agency usually cannot be stated in dollars.


Table 15.1 Marginal Product of Labor, Marginal Revenue Product of

Labor, and Marginal Cost


Figure 15.1a Labor Market Equilibrium

Labor supplycurve

MRPL, Labordemand curve

L, Workers per hour

620 3 4 5

(a) Labor Profit-Maximizing Condition

6

w = 12

9

18

15

w, V

MP

L, $

pe

r un

it


Figure 15.1b Output Market Equilibrium

MC

p

27130 18 22 25

2

3

2.4

6

4

q, Units of output per hour

(b) Output Profit-Maximizing Condition

MC

, p, $

pe

r un

it


Labor Markets & the Distribution of Income

Labor earnings are the main source of income.

So the nature of the labor market has an enormous impact on the distribution of income.

No theorem says that competition leads to

a distribution that is fair.


Evidence on Inequality

Peter Gottschalk and Sheldon Danziger, “Inequality of Wage Rates, Earnings and Family Income in The United States, 1975–2002,” Review of Income and Wealth, Series 51, Number 2, June 2005, pp. 231-254.

“While there is still considerable uncertainty about the causes of these changes, there is broad consensus that wage rate inequality is considerably higher at the start of the 21st century than it was a quarter of a century earlier. In fact, increases in wage rate and annual earnings inequality occurred primarily in the early 1980s, and were not reversed by a prolonged economic recovery during the 1990s.”


Inequality in Wages and income


Education and Earnings

Workers are paid the value of their marginal product.

More productive workers are paid more.Education is the best way to become more

productive.The returns to education are large and

have been increasing over time, leading to more inequality.


The Growing Return to Education


Discrimination in Labor Markets

Economic tools shed light on (but cannot, of course, fully explain) discrimination.

Because discrimination touches on values that many people feel strongly about, clear thinking requires precise definitions and careful attention to the positive/normative distinction.


Definitions for Studying Discrimination, 1

Race – A social classification of people based on superficial, easily observed physical traits with meaning in a particular society.

All humans are descended from Africans and share most of their genetic make-up.

The distribution of traits varies widely within any racial group, however defined.

There is no evidence that any racial group, however defined, is intrinsically different on any substantive trait.

Ethnicity – A social classification of people based on cultural characteristics, such as customs, language, religion, and nationality, that have been given meaning in a particular society.

In the U.S., Hispanic is an ethnic designation, as is Jewish or Italian or Muslim or Arab.


Definitions for Studying Discrimination, 2

Racial or Ethnic Prejudice is a strong negative attitude toward or belief about the members of a particular racial or ethnic group.

Racial or Ethnic Discrimination is behavior that denies the members of a racial or ethnic group the rights or privileges to which they are entitled.

Discrimination cannot be defined without determining entitlements. In the U.S., a firm can use any reasonable set of qualifications to

determine whether to hire, fire, promote, or train someone But this set of qualifications cannot include membership in a legally

protected class (race, religion, ethnicity, sex).

Segregation is the physical separation of different racial or ethnic groups (in employment, housing, etc.)


Theories of Discrimination

Discrimination can have many different causes, includingEmployer prejudiceEmployee prejudiceCustomer prejudiceSignaling (statistical discrimination)

Discrimination is illegal regardless of the incentives that lead people to engage in it.


Model 1: Employer Prejudice

If an employer is prejudiced against people from a protected class, he/she must be compensated to hire them.

Let d indicate the profits a prejudiced employer is willing to forgo to avoid hiring a black. Then the employer keeps hiring whites until

but uses a different standard for hiring blacks, namely

For equally productive workers, it follows that

Since d is positive, prejudiced employers offer a higher wage to whites than to blacks. This is clear-cut wage discrimination.

= L WVMP W

= + L BVMP W d

W BW W d


Model 2: Employee Prejudice

Now suppose employers aren’t prejudiced, but white employees are; in this case, hiring blacks raises the wage that must be paid to attract white employees.

Assume that blacks do not care about the racial composition of the workforce. (Other cases are obviously possible.)

Now if

Ww at 100% white < WB, the firm hires only whites Ww at 100% white = WB, the firm hires whites or blacks, but not

both Ww at 100% white > WB, the firm hires only blacks

Hence this model predicts firms will practice hiring discrimination to enforce complete workforce segregation, by firm or by occupation within a firm.


Model 3: Customer Prejudice

Employers may discriminate in an attempt to satisfy the prejudices (expected or actual) of their customers.

For example, a management consulting firm that gives advice to male CEO’s who do not want women to tell them what to do might (illegally!) discriminate against female applicants.


Statistical Discrimination Statistical discrimination can arise when some

worker characteristics, such as dedication or ability to learn on the job, cannot be observed at the time of hiring.

Employers may assume that a person has the average value for these unobserved traits for her (or his) group.

If past discrimination has left her group with lower values of these traits, then the employer will discriminate against her.

This is illegal; an employer cannot make decisions about an individual based on average traits for that individual’s group.


Evidence on Discrimination, 1

Marianne Bertrand and Sendhil Mullainathan, “Are Emily and Greg More Employable than Lakisha and Jamal?” American Economic Review, October 2004.

This study sent fictitious resumes to help-wanted ads in Boston and Chicago newspapers. Each resume was assigned either a very African American sounding name or a very White sounding name.

“The results show significant discrimination against African-American names: White names receive 50 percent more callbacks for interviews. We also find that race affects the benefits of a better resume. For White names, a higher quality resume elicits 30 percent more callbacks whereas for African Americans, it elicits a far smaller increase.”


Evidence on Discrimination, 2

Claudia Golden and Cecilia Rouse, “Orchestrating Impartiality: The Impact of Blind Auditions on Female Musicians, American Economic Review, September 2000.

A “blind” audition procedure, in which people tried out for an orchestra behind a screen, increased the number of women hired by roughly 50 percent.

ppa 723: managerial economics lecture 16: input markets the maxwell school, syracuse university...

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