What to Read For in what market do consumers earn the income they spend on goods?
What is derived demand? Do firms hire labor for what the labor can do, or for who the laborer is? How does one portray racial discrimination in the labor market? Does the minimum wage make people better off?
It is now time to close the economy—"close" meaning to finish the Wheel of Wealth. The Wheel, you will recall, arrayed consumers on one side and firms on the other, as on the left-hand side of Figure 22.1. The top flows are the markets of the goods that have been the explicit subject of the analysis so far: corn, natural gas, housing, books, college education, and so forth. The bottom flow is the subject of the next five chapters, the market for the services of factors of production such as labor, land, and capital.
The factors of production are those basic inputs from which all commodities can be thought of as flowing. Look at your pencil. True, it is made of wood: no factor of production there. But look a little harder. Where did the wood come from? Well, it came ultimately from land, labor, and capital—the land of a forest combined with the labor of the lumberjack and the capital of the sawmill operator cooperated to produce a piece of wood, fashioned at later stages into a wooden pencil.
Analysis of this sort, in truth, finding in each commodity the "ultimate" factors of production that made it, is more persuasive than it has any right to be. After all, the sawmill's saw was itself produced by labor and land and capital; and the laborer is what he eats. Nothing is really "ultimate" or "basic." The Wheel of Wealth is indeed a wheel, with no beginning or end. Like salt or
The solid lines represent the flow of goods and services from firms to consumers and the flow of factor services (labor, for instance) from consumers to firms. The dashed lines represent the money payments for these flows, the one being national product, the other national income. The next few chapters concern the lower, factor market.
Dollar Values of Wages, Interest, and Rents (National Income)
Dollar Values of Wages, Interest, and Rents (National Income)
sugar, however, the story of basic factors of production is not too bad if you do not take too much of it.
The spending on commodities that comes out of the households on one side of the Wheel must come into the households on the other side as income. That is, what factors of production earn is income, the income that is spent on commodities. The way in which the households earn their income, in other words, is to sell their services—services of their labor or their land or their capital—in a market in which they are sellers and the firms are buyers. The market is called the market for factors of production. It finishes the Wheel and, as was just said, closes the model. In a sense, then, by this step the analysis of the economy is finished.
The Law of One Price The mere idea that the factors of production sell in a market is a boon to Applies to Labor anyone attempting to measure the rewards to those factors. If the market is Markets functioning well and the cost of moving from one part of the market to another is not very great, then the price of all factors of production of a particular sort and quality must be the same. All land in a city must earn the same rent, once the special advantages of particularly favorable locations have been allowed for. All common laborers in the same country must earn the same wage. All machines of the same productivity must rent or sell for the same price. Factors of production, in other words, are to be treated like grains of wheat or tons of steel: as fungible.
T or F: The indexes of wages of building artisans in England over the past seven centuries are inadequate because they refer overwhelmingly to wages in southern England, especially in London and in a few cathedral towns.
A: More information is always better than less, to be sure. It would be nice to have wages from the North. But to suppose without further argument that a sample based on the South is wrong is to suppose that England as a whole did not constitute, roughly, a single market for labor. Perhaps it did not. But that it did not needs to be shown, not merely assumed without evidence. And if it was a single market, little is gained by looking further into regional wages—except perhaps to confirm the very oneness of the market or to detect some persistent superiority of one region's wages over another's due to differences in the cost of living, say, or climate.
A New Idea: Derived Nothing so far is analytically new. The substantive novelty in the analysis of Demand the demand for labor can be summarized in the phrase derived demand. The demand for labor is largely a derived demand, that is, a demand not directly by consumers but by firms who will then use the labor to satisfy the demands of consumers. In fact, the only reason for the firms to buy the labor is to satisfy the demands of consumers. If a certain laborer cannot produce for the firm enough consumer satisfaction to pay his wage, the firm simply does not hire the laborer. The demand for the laborer's services is derived from the demand for whatever the firm makes, such as popcorn, crackerjacks, or baseball.
Q: Pete Rose was a baseball player of high skill, a great pleaser of crowds, a star. True or false: Rose was, at $800,000 a year, overpaid by the Philadelphia Phillies.
A: If someone pays Rose such a sum, that someone believes that Rose will earn the club an amount equal to the sum or more. The owner of the Phillies is not in the business for his health. The payment was mutually advantageous or it would not have been made. The owner was willing to pay and therefore did not "over pay." The only meaning of "overpay" is one that objected to Rose's being paid so much "merely" for hitting, throwing, and catching a baseball superbly well. But behind the willingness of the owner to pay Rose is the willingness of the fans to pay the owner. Would it make sense to object to 3 million separate deals between Pete Rose and his fans to put on an exhibition of his skills? No. The demand for Rose is a derived demand.
The point applies to all businesses and to "underpaying" as well as to "overpaying." Geoffrey Hellman wrote for the New Yorker magazine for a long time and had incessant quarrels with its editor, Harold Ross, about how little Ross paid a man of Hellman's seniority. Ross insisted that he paid what each piece of writing was worth:
You say that you have been here eighteen years and are not treated better than a good writer a couple of years out of college would be, so far as pay for individual articles is concerned. . . . My firm viewpoint is that we ought to pay what a piece is worth, regardless of age, race, color, creed, financial status or any other consideration. I don't know how, in an enterprise of this sort, one in my position can take into consideration anything beyond the actual value of the things.1
The point is that employers are not to be viewed as having tastes for employ-ees in the way that consumers have tastes for apples or oranges. The steelworker makes steel that Bethlehem Steel turns around and sells to automakers. It is not the steelworker that makes the owners of the company happy directly but the indirect profit from the worker's work.
There will be cases that violate the point, of course. An important case in which the hired employee himself does directly enter the utility function of the owner, instead of merely as an instrument for making money, is the case of discrimination in hiring, in favor of native-born citizens, say, or against blacks.
The diagram is in Figure 22.2. Notice that the number of firms with a given degree of discrimination is assumed constant—invariant, that is, to the wage paid. A perfectly functioning market would increase the elasticity of the curve, whatever its level, by driving out firms that discriminated a lot until all firms had the lowest discrimination (not necessarily zero) available among the class of potential employers. The point is that a firm that did not hire black workers— that indulged its taste—would pay more for labor than would a firm that took advantage of the lower wage for blacks. This applies across industries—relatively nondiscriminatory industries would have lower costs than they would in the absence of discrimination elsewhere. It is said that the radical shifts in the racial composition of the work force in the New York garment trades is a result of this mechanism.
As useful as the exception is for analyzing some situations, it must be realized that it is indeed an exception. Most employers are cold-blooded about hiring, within narrow limits. That does not mean they are fair in the ordinary sense of the word, merely that they are cold-bloodedly efficient, which has its own charm. If a secretary does not do his job well, he will lose it. If he is obviously incapable of performing the job, he will not get it in the first place. If he is competent but demands special treatment of an expensive sort, again he will not get it. The discipline of the market stands ready to punish an employer who is anything but calculating in this way. If he is the owner, he will be competed to bankruptcy by competitors who do watch the value they get from the people they hire. If he is a hired manager he himself will be fired if he makes a habit of indulging his preference for white Anglo-Saxon Protestants
'Quoted in Brendan Gill, Here at the New Yorker (New York: Random House, 1975), p. 360.
2 See William Landes, "The Economics of Fair Employment Laws," /ourrtal of Political Economy 76 (July-August 1968): 507-552, especially pp. 509-510; and Gary Becker, The Economics of Discrimination, 2nd ed. (Chicago: University of Chicago Press, 1971), pp. 5-85.
Q: If employers, to a varying degree, have a distaste for hiring black workers rather than white workers at the same wage, then a rise in the proportion of blacks to whites in a labor market will be accompanied by a fall in the relative wages of blacks.
be paid the same wages (assuming that blacks and whites are identical except for color), or else the low-wage person will undersell the high-wage one. So the black wage is determined by the wage differential that just compensates the most discriminatory employer hiring any black for hiring "the" marginal one. Therefore, true.2
A: As the proportion rises, the blacks must face more and more discriminatory employers. All blacks must
The Economics of Discrimination
If there are few blacks in a labor market, then the least discriminatory employers will be able to hire them and in competing to hire them will keep their wages high. If the numbers increase, then more discriminatory employers will need to hire blacks, which they will only do if compensated by paying them lower wages than whites. For this reason the demand curve slopes downward. For the same reason a shift outward in the relative supply curve of blacks causes their wage to fall (it would not if blacks and whites were treated as identical by employers).
Supply Curve Before Increase
Supply Curve After Increase
Supply Curve Before Increase
Supply Curve After Increase
Zero Discrimination Line (equal wages)
Ratio of Blacks to Whites in a Local Market as cooks when all the competition is using another sort of person that is cheaper to hire. In short, it is a premise of the theory of the firm that employers normally do not indulge their own tastes. They hire to satisfy their customers' tastes, the better to enrich themselves.
The Law of Demand Although employers do not normally have tastes in employees, they do normally Applies to Labor as exhibit the behavior that consumers (with tastes) exhibit in the face of varying a Commodity prices, namely, downward-sloping demand. The precise reasons for the parallelism between the theory of the demand for households and the theory of demand for firms is taken up later. The common sense of the matter is persuasive. At a high price for secretaries an insurance company will ration out the secretaries to its executives in small numbers. At a low price every suboffice of the company will have two or three. There are not, in other words, fixed and limited "slots,"
and jobs are not "created." The jobs to be done by the insurance company are unlimited. It could always use another person to organize the files just a little bit better, to handle claims just a little bit faster, and (above all) to collect premiums just a little more promptly. But doing these things a "little bit" more will not be worthwhile if the price of the person to do them is high. Only the most important secretarial tasks should get done if the secretary's price is high. For this reason it will be rational for the company to be stingy with secretarial time when it is expensive, and generous with secretarial time when it is cheap. That is, the company has a downward-sloping demand curve for secretaries. And likewise for other people hired.
By the usual argument, if the demand curve for each company slopes downward, the demand curve for an entire industry probably slopes downward. And indeed- as will be shown presently, the demand curve slopes downward for the entire economy as well.
Uses of the Demand That the demand for labor is a curve, not a point, is a tremendously important for Labor fact. It undermines, for example, all manner of manpower studies, projections, "needs," "supplies," and other products of the official imagination eager to find in its vision of the future a reason to act or not to act. "Demand for Nurses Outruns Supply" screams the headline. Why, the economist replies, do the wages of nurses not increase? "Shortage of Engineers Developing" screams another. But will not the consequent rise in wages provide the remedy? It is simply wrong to speak in terms of "the" supply or "the" demand of nurses or engineers as though each were a number, such as 1 million. The demand (and as Chapter 25 will show, the supply also) is dependent on the wage, the wage itself being determined inside the very market being discussed.
Q: Before the founding of the state of Israel, the administrators of the British Mandate in Palestine prohibited more than a certain number of lews from immigrating. The number was lower than the number who wished to immigrate, with terrible consequences. One reason given for restricting immigration was that more than a small number would flood the labor market and result in unemployment. That is, the British believed that there were just so many slots in the economy: To pour more people into the given slots would be irresponsible and foolish. Comment.
A: The belief is another example of the tragedy of Palestine, in this case a tragedy complicated by mistaken economics. If jobs were slots, the British would have been right. But jobs are not slots. Jobs exist because at the going wage employers wish to hire people in that number. If there are more people, then by the usual workings of supply and demand the wage will fall to induce employers to take up more of the workers. If more immigrants came the wage would fall. Perhaps this is what the British truly feared: impoverishment of the existing population. In fact, Israel came into existence, lews poured into Israel in large numbers, and unemployment turned out to be small and diminishing.
An example closer to home, if your home is the United States, is the minimum wage. According to the law most employers are not permitted to pay anyone less than some amount per hour.
Q: Use supply and demand curves to begin an analysis of the effects of the minimum wage.
A: Simply treat the labor market like any other, such as wheat. If the price of wheat is supported by law, then there will be "unemployed" wheat, that is, a surplus of wheat produced over what is consumed. Likewise with labor. If the wage is supported by law, then there will be a surplus of labor, called "unemployment." The hour that is worth $1 will not be used if an hour must by law be paid $4. As usual in economic arguments, the point is made clearer by going to an extreme. Suppose that the minimum wage were S50 an hour. In that case only doctors would have jobs. The rest of us would be prevented by the state from
At a wage allowed to reach $1 an hour the supply of labor equals the demand. If the wage is held at $4 an hour, however, the quantity supplied is higher and the quantity demanded is lower, leaving Unemployment.
engaging in an exchange with our employer. I may be willing to work for $6 an hour; my employer may be willing to pay me the $6 for the hour, but the state forbids the deal. The unemployed victim of such interference may be forgiven for wondering about the state's claim to be "protecting" the very worker who loses the job. In any event, a worker whose value to the employer is less than the minimum wage per hour simply does not get employed. If jobs were fixed slots, the demand curve for workers would be inelastic, and the low-value worker would be hired. But if jobs are not fixed slots (and they are not), the minimum wage forces the company up its demand curve and the low-value worker is not hired. The result is portrayed in Figure 22.3.
The usual example of this effect is unemployment among teenagers. Present company excepted, teenagers are on the whole less reliable, prompt, responsible, strong, and skilled than adult workers. They are therefore, by the logic of derived demand, less useful to, say, a manufacturing company. They are not worthless, but worth less. A minimum wage would therefore be expected to cause disproportionate unemployment among teenagers. It does. , i\
COMMENT The assertion that the minimum wage causes unemployment and especially that it causes it among teenagers is controversial. It is fair to say that most economists believe the assertion.3 But some do not believe it, on various grounds. One line of counterargument is that the minimum wage encourages j ■Af^'1 businesses to improve the machinery, buildings, materials, and other things ■
workers work with to justify the higher wage paid. It is argued that an unskilled worker pushing a broom is not as valuable as the same worker pushing a $1500 automatic broom-mop-waxer. There is an element of confusion in the > W
argument, for it must be admitted that if it were good for the economy to q^
invest in such automatic equipment before the minimum wage the economy /
might well have done so already. And if it were bad for the economy it is strange to argue that the investment thus induced artificially by the minimum wage is a good thing. Another arid more persuasive line of argument, which will be taken up again in Section 25.2, is that working conditions will adjust to offset the higher wages. A slow janitor at $2 an hour is no better bargain to the company than a fast one at, say, $5. The company that hires the janitor will be willing to pay the higher price if it can specify that the janitors rush around at top speed. A faster pace of work or a greater degree of self-supervision or a higher standard of precision might all tend to compensate for the higher wage paid. This line of argument, however, has the same fault as the first. True as it may be, it does not necessarily justify the minimum wage. The mix of wages and conditions that existed before the state intervened in exchange presumably had some desirable feature, or else it would already have been bargained away. In the end the argument in favor of the minimum wage must come down to a simple distaste for the result of exchange in the absence of intervention. The feeling is that we simply should not tolerate anyone in a job so undignified that it was worth only $2 an hour. Better that such people be supported by the rest of us, or even starve, than that they be required to work at such a job.
A less controversial example of the same point, familiar from Chapter 15, is the following.
T or F: That employers are required by law to pay half A: The employers have a downward-sloping demand for of the cost of social security taxes is irrelevant to the labor. The demand price is what they are willing to real burden of the tax. pay for an additional hour of work in view of what
3 In J. R. Kearl, Clayne L. Pope, Gordon C. Whiting, and Larry T. Wimmer, "A Confusion of Economists," American Economic Review 69 (May 1979): 28-37, it was found that 68% of economists "generally agreed" with the proposition that "a minimum wage increases unemployment among young and unskilled workers," 22% agreed with some provisions (see the text following), and only 10% flatly disagreed.
the hour can earn for them in profits. But if their share of the tax is, say, 5% of the wages they pay, they will get 5% less profit, and their willingness to pay falls by 5%. The 5% imposed "on" employers results in a fall in the demand for labor by employers as a group. But the fall in demand results in a fall in the wage, as the intersection of supply and demand moves back down along the supply curve. Fewer workers are employed at a lower wage than before the tax was imposed
"on" the employers. In short, true. The workers bear some of the burden. The 50:50 split of the tax between workers and employers is irrelevant for answering the question of who really bears the burden. What are relevant, as is always the case in such problems of supply and demand, are the elasticities of supply and demand and the total size of the tax, regardless of how it is apportioned legally among participants in the market.
Summary The leading point is that firms have demand curves. That such an extension of the law of demand should have so many applications will come as no surprise. On a formal level, the law of demand for firms serves to close the economy, giving households somewhere to earn the income that they spend in other markets on the products of firms. At a more substantive level, the result is that all the machinery of demand and supply curves applies to labor markets. The real surprises come from the proposition that firms buy labor in order to use it, not to admire it. That is, unlike the demand of households, the demand of firms for what they demand is "derived." The violation of this proposition gives a way of analyzing discrimination in the labor market. Its fulfilment gives a way of looking at all manner of ersatz economics that speaks of jobs as slots, such as labor "requirements" and the belief in the power of acts of Congress raising the wage to benefit working people. What remains is to understand the derivation of the firm's demand for labor more deeply.
° 1. One interpretation of the arrangements in early nineteenth-century England for aiding the poor (the so-called "old Poor Law") is that they applied money from taxing farmers to subsidizing the employment of poor people in the hire of the same farmers. The chief objections to the arrangement were two. First, it made the workers less dependent on the farmer for their income and more dependent on the government (in this case the local government of the village), thus undermining the respect of workers for their employers. Second, it reduced the effort of the workers, by enriching them. Decide which if any of these two propositions is correct by analyzing the old Poor Law in terms of the supply and demand for agricultural labor. Assume that the demand curve was unaffected by the tax (an argument can be made that it was not).
2. Private schools in Chicago often complain that the large increases in the wages of public school teachers increase the wages the private schools have to pay their teachers.
a. One conceivable method of hiring public school teachers in Chicago would be to announce a wage and to hire all qualified teachers who applied. If this were the method, would the complaint be true or false?
b. One interpretation of the actual method of hiring public school teachers is that the demand curve of the public schools is perfectly inelastic (they "need" N thousand), entry to employment is limited to N thousand (all being members of the teacher's union), the wage is held above the market clearing price, and increases in wages are granted in response to the political power and strike threats of the union. Under this interpretation is the complaint of the private schools true or false?
c. An alternative interpretation is that the union chooses a wage to demand this year,
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