Principlis of economics / principles_of_economics_gregory_mankiw

CHAPTER 19 EARNINGS AND DISCRIMINATION	433

IN THE NEWS

The Recent Push for Comparable Worth

too long, working women have seething while politicians have resilent,” said Karen Nussbaum, of the AFL-CIO’s Working department. “Pay equity can

long-standing wrong.” . . .

Diana Furchtgott-Roth, a resident felthe American Enterprise Institute, there are plenty of reasons why men women earn different wages—senior- job risk, and market demand for cer- skills—that have nothing to do with

discrimination and would not be erased by “cockeyed” pay-equity laws. She said you compare men and women with same qualifications doing the same women earn 95 percent of men’s

.

“Comparable worth is certainly mak- a comeback,” Furchtgott-Roth said, I believe it’s because feminists who

supported Clinton through the Lewinsky are demanding a political payoff. I see any Republican support for proposals.”

: The Boston Globe, February 25, 1999, pp. A22.

The theory of the labor plains why some workers earn not say that the resulting

way. That is the topic we take up

Summar y

Workers earn different wages for many reasons. To some extent, wage differentials compensate workers for job attributes. Other things equal, workers in hard, unpleasant jobs get paid more than workers in easy, pleasant jobs.

Workers with more human capital get paid more than workers with less human capital. The return to

accumulating human capital is high and has increased over the past decade.

Although years of education, experience, and job characteristics affect earnings as theory predicts, there is much variation in earnings that cannot be explained by things that economists can measure. The unexplained variation in earnings is

434	PART SIX THE ECONOMICS OF LABOR MARKETS

largely attributable to natural ability, effort, and chance.

Some economists have suggested that more educated workers earn higher wages not because education raises productivity but because workers with high natural ability use education as a way to signal their high ability to employers. If this signaling theory were correct, then increasing the educational attainment of all workers would not raise the overall level of wages.

Wages are sometimes pushed above the level that brings supply and demand into balance. Three reason for above-equilibrium wages are minimum-wage laws, unions, and efficiency wages.

Some differences in earnings are discrimination on the basis of

Measuring the amount of discrimination is difficult, however, because one must correct for differences in human capital and job characteristics.

Competitive markets tend to limit the impact of discrimination on wages. If the wages of a group of workers are lower than those of another group for reasons not related to marginal productivity, then nondiscriminatory firms will be more profitable than discriminatory firms. Profit-maximizing behavior, therefore, can act to reduce discriminatory wage differentials. Discrimination can persist in competitive markets if customers are willing to pay more to discriminatory firms or if the government passes laws requiring firms to discriminate.

	Key Concepts
compensating differential, p. 419	comparable worth, p. 432
human capital, p. 419
union, p. 425
	Questions for Review

1.Why do coal miners get paid

with similar amounts of education?

2.In what sense is education a type

3.How might education raise a raising the worker’s productivity?

4.What conditions lead to economic expect to see superstars in dentistry?

5.Give three reasons why a worker’s above the level that balances

in deciding whether a group lower wage because of

economic competition tend to discrimination on the basis of

how discrimination might persist in

.

Problems and Applications

1.College students sometimes work as summer interns for private firms or the government. Many of these positions pay little or nothing.

a.What is the opportunity cost of taking such a job?

b.Explain why students are willing to take these jobs.

c.If you were to compare the earnings later in life of workers who had worked as interns and those who

had taken summer jobs that paid more, what would you expect to find?

2.As explained in Chapter 6, a minimum-wage law distorts the market for low-wage labor. To reduce this distortion, some economists advocate a two-tiered minimum-wage system, with a regular minimum wage for adult workers and a lower, “sub-minimum” wage

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for teenage workers. Give two reasons why a single minimum wage might distort the labor market for teenage workers more than it would the market for adult workers.

3.A basic finding of labor economics is that workers who have more experience in the labor force are paid more than workers who have less experience (holding constant the amount of formal education). Why might this be so? Some studies have also found that experience at the same job (called “job tenure”) has an extra positive influence on wages. Explain.

4.At some colleges and universities, economics professors receive higher salaries than professors in some other fields.

a.Why might this be true?

b.Some other colleges and universities have a policy of paying equal salaries to professors in all fields. At some of these schools, economics professors have lighter teaching loads than professors in some other fields. What role do the differences in teaching loads play?

5.Sara works for Steve, whom she hates because of his snobbish attitude. Yet when she looks for other jobs, the best she can do is find a job paying $10,000 less than her current salary. Should she take the job? Analyze Sara’s situation from an economic point of view.

6.Imagine that someone were to offer you a choice: You could spend four years studying at the world’s best university, but you would have to keep your attendance there a secret. Or you could be awarded an official degree from the world’s best university, but you couldn’t actually attend. Which choice do you think would enhance your future earnings more? What does your answer say about the debate over signaling versus human capital in the role of education?

7.When recording devices were first invented almost 100 years ago, musicians could suddenly supply their music to large audiences at low cost. How do you suppose this event affected the income of the best musicians? How do you suppose it affected the income of average musicians?

8.Alan runs an economic consulting firm. He hires primarily female economists because, he says, “they will work for less than comparable men because women

have fewer job options.” Is Alan’s behavior admirable or despicable? If more employers were like Alan, what would happen to the wage differential between men and women?

9.A case study in this chapter described how customer discrimination in sports seems to have an important effect on players’ earnings. Note that this is possible because sports fans know the players’ characteristics, including their race. Why is this knowledge important for the existence of discrimination? Give some specific examples of industries where customer discrimination is and is not likely to influence wages.

10.Suppose that all young women were channeled into careers as secretaries, nurses, and teachers; at the same time, young men were encouraged to consider these three careers and many others as well.

a.Draw a diagram showing the combined labor market for secretaries, nurses, and teachers. Draw a diagram showing the combined labor market for all other fields. In which market is the wage higher? Do men or women receive higher wages on average?

b.Now suppose that society changed and encouraged both young women and young men to consider a wide range of careers. Over time, what effect would this change have on the wages in the two markets you illustrated in part (a)? What effect would the change have on the average wages of men and women?

11.Economist June O’Neill argues that “until family roles are more equal, women are not likely to have the same pattern of market work and earnings as men.” What does she mean by the “pattern” of market work? How do these characteristics of jobs and careers affect earnings?

12.This chapter considers the economics of discrimination by employers, customers, and governments. Now consider discrimination by workers. Suppose that some brunette workers did not like working with blonde workers. Do you think this worker discrimination could explain lower wages for blonde workers? If such a wage differential existed, what would a profit-maximizing entrepreneur do? If there were many such entrepreneurs, what would happen over time?

I N C O M E I N E Q U A L I T Y

A N D P O V E R T Y

“The only difference between the rich and other people,” Mary Colum once said to Ernest Hemingway, “is that the rich have more money.” Maybe so. But this claim leaves many questions unanswered. The gap between rich and poor is a fascinating and important topic of study—for the comfortable rich, for the struggling poor, and for the aspiring and worried middle class.

From the previous two chapters you should have some understanding about why different people have different incomes. A person’s earnings depend on the supply and demand for that person’s labor, which in turn depend on natural ability, human capital, compensating differentials, discrimination, and so on. Because labor earnings make up about three-fourths of the total income in the U.S. economy, the factors that determine wages are also largely responsible for determining how the economy’s total income is distributed among the various members of society. In other words, they determine who is rich and who is poor.

IN THIS CHAPTER YOU WILL . . .

Examine the degr ee of economic inequality in our society

Consider some pr oblems that arise

when measuring economic inequality

See how political philosophers view the government’s r ole in

r edistributing income

Consider the various policies aimed at helping poor families escape pover ty

437

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In this chapter we discuss the distribution of income. As we shall see, this topic raises some fundamental questions about the role of economic policy. One of the Ten Principles of Economics in Chapter 1 is that governments can sometimes improve market outcomes. This possibility is particularly important when considering the distribution of income. The invisible hand of the marketplace acts to allocate resources efficiently, but it does not necessarily ensure that resources are allocated fairly. As a result, many economists—though not all—believe that the government should redistribute income to achieve greater equality. In doing so, however, the government runs into another of the Ten Principles of Economics: People face tradeoffs. When the government enacts policies to make the distribution of income more equitable, it distorts incentives, alters behavior, and makes the allocation of resources less efficient.

Our discussion of the distribution of income proceeds in three steps. First, we assess how much inequality there is in our society. Second, we consider some different views about what role the government should play in altering the distribution of income. Third, we discuss various public policies aimed at helping society’s poorest members.

THE MEASUREMENT OF INEQUALITY

We begin our study of the distribution of income by addressing four questions of measurement:

How much inequality is there in our society?

How many people live in poverty?

“As far as I’m concerned, they can do what they want with the minimum wage, just as long as they keep their hands off the maximum wage.”

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What problems arise in measuring the amount of inequality?

How often do people move among income classes?

These measurement questions are the natural starting point from which to discuss public policies aimed at changing the distribution of income.

U.S. INCOME INEQUALITY

There are various ways to describe the distribution of income in the economy. Table 20-1 presents a particularly simple way. It shows the percentage of families that fall into each of seven income categories. You can use this table to find where your family lies in the income distribution.

For examining differences in the income distribution over time or across countries, economists find it more useful to present the income data as in Table 20-2. To see how to interpret this table, consider the following thought experiment. Imagine that you lined up all the families in the economy according to their annual income. Then you divided the families into five equal groups: the bottom fifth, the second fifth, the middle fifth, the fourth fifth, and the top fifth. Next you computed the share of total income that each group of families received. In this way, you could produce the numbers in Table 20-2.

These numbers give us a way of gauging how the economy’s total income is distributed. If income were equally distributed across all families, each one-fifth of families would receive one-fifth (20 percent) of income. If all income were concentrated among just a few families, the top fifth would receive 100 percent, and the other fifths would receive 0 percent. The actual economy, of course, is between these two extremes. The table shows that in 1998 the bottom fifth of all families received 4.2 percent of all income, and the top fifth of all families received 47.3 percent of all income. In other words, even though the top and bottom fifths include the same number of families, the top fifth has about ten times as much income as the bottom fifth.

The last column in Table 20-2 shows the share of total income received by the very richest families. In 1998, the top 5 percent of families received 20.7 percent of total income. Thus, the total income of the richest 5 percent of families was greater than the total income of the poorest 40 percent.

Table 20-2 also shows the distribution of income in various years beginning in 1935. At first glance, the distribution of income appears to have been remarkably stable over time. Throughout the past several decades, the bottom fifth of families

ANNUAL FAMILY INCOME	PERCENT OF FAMILIES
Less than $15,000	11.7%
$15,000-$24,999	12.3
$25,000-$34,999	12.7
$35,000-$49,999	16.8
$50,000-$74,999	21.5
$75,000-$99,999	11.7
$100,000 and over	13.3

Table 20-1

THE DISTRIBUTION OF INCOME IN

THE UNITED STATES: 1998

Source: U.S. Bureau of the Census.

440	PART SIX THE ECONOMICS OF LABOR MARKETS

Table 20-2

INCOME INEQUALITY IN THE

UNITED STATES. This table shows the percent of total beforetax income received by families in each fifth of the income distribution and by those families in the top 5 percent.

	BOTTOM	SECOND	MIDDLE	FOURTH	TOP	TOP
YEAR	FIFTH	FIFTH	FIFTH	FIFTH	FIFTH	5 PERCENT
1998	4.2%	9.9%	15.7%	23.0%	47.3%	20.7%
1990	4.6	10.8	16.6	23.8	44.3	17.4
1980	5.2	11.5	17.5	24.3	41.5	15.3
1970	5.5	12.2	17.6	23.8	40.9	15.6
1960	4.8	12.2	17.8	24.0	41.3	15.9
1950	4.5	12.0	17.4	23.4	42.7	17.3
1935	4.1	9.2	14.1	20.9	51.7	26.5

Source: U.S. Bureau of the Census.

has received about 4 to 5 percent of income, while the top fifth has received about 40 to 50 percent of income. Closer inspection of the table reveals some trends in the degree of inequality. From 1935 to 1970, the distribution gradually became more equal. The share of the bottom fifth rose from 4.1 to 5.5 percent, and the share of the top fifth fell from 51.7 percent to 40.9 percent. In more recent years, this trend has reversed itself. From 1970 to 1998, the share of the bottom fifth fell from 5.5 percent to 4.2 percent, and the share of the top fifth rose from 40.9 to 47.3 percent.

In Chapter 19 we discussed some of the reasons for this recent increase in inequality. Increases in international trade with low-wage countries and changes in technology have tended to reduce the demand for unskilled labor and raise the demand for skilled labor. As a result, the wages of unskilled workers have fallen relative to the wages of skilled workers, and this change in relative wages has increased inequality in family incomes.

CASE STUDY THE WOMEN’S MOVEMENT AND

THE INCOME DISTRIBUTION

Over the past several decades, there has been a dramatic change in women’s role in the economy. The percentage of women who hold jobs has risen from about 32 percent in the 1950s to about 54 percent in the 1990s. As full-time homemakers have become less common, a woman’s earnings have become a more important determinant of the total income of a typical family.

Although the women’s movement has led to more equality between men and women in access to education and jobs, it has also led to less equality in family incomes. The reason is that the rise in women’s labor-force participation has not been the same across all income groups. In particular, the women’s movement has had its greatest impact on women from high-income households. Women from low-income households have long had high rates of participation in the labor force, even in the 1950s, and their behavior has changed much less.

In essence, the women’s movement has changed the behavior of the wives of high-income men. In the 1950s, a male executive or physician was likely to marry a woman who would stay at home and raise the children. Today, the wife of a male executive or physician is more likely to be an executive or physician herself. The result is that rich households have become even richer, a pattern that raises inequality in family incomes.

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As this example shows, there are social as well as economic determinants of the distribution of income. Moreover, the simplistic view that “income inequality is bad” can be misleading. Increasing the opportunities available to women was surely a good change for society, even if one effect was greater inequality in family incomes. When evaluating any change in the distribution of income, policymakers must look at the reasons for that change before deciding whether it presents a problem for society.

EQUALITY FOR WOMEN HAS MEANT

LESS EQUALITY FOR FAMILY INCOMES.

CASE STUDY INCOME INEQUALITY AROUND THE WORLD

How does the amount of income inequality in the United States compare to that in other countries? This question is interesting, but answering it is problematic. For many countries, data are not available. Even when they are, not every country in the world collects data in the same way; for example, some countries collect data on individual incomes, whereas other countries collect data on family incomes. As a result, whenever we find a difference between two countries, we can never be sure whether it reflects a true difference in the economies or merely a difference in the way data are collected.

With this warning in mind, consider Table 20-3, which compares the income distribution of the United States to that of seven other countries. The countries

COUNTRY	BOTTOM FIFTH	SECOND FIFTH	MIDDLE FIFTH	FOURTH FIFTH	TOP FIFTH
Germany	9.0%	13.5%	17.5%	22.9%	37.1%
Canada	7.5	12.9	17.2	23.0	39.3
Russia	7.4	12.6	17.7	24.2	38.2
United Kingdom	7.1	12.8	17.2	23.1	39.8
China	5.5	9.8	14.9	22.3	47.5
United States	4.8	10.5	16.0	23.5	45.2
Chile	3.5	6.6	10.9	18.1	61.0
Brazil	2.5	5.7	9.9	17.7	64.2

	INCOME INEQUALITY AROUND THE WORLD. This table shows the percent of total before-	Table 20-3
	tax income received by families in each fifth of the income distribution.

Source: World Development Report: 1998/99, pp. 198–199.

442	PART SIX THE ECONOMICS OF LABOR MARKETS

pover ty rate

the percentage of the population whose family income falls below an absolute level called the poverty line

pover ty line

an absolute level of income set by the federal government for each family size below which a family is deemed to be in poverty

are ranked from the most equal to the most unequal. On the top of the list is Germany, where the richest fifth of the population has income only about 4 times that of the poorest fifth. On the bottom of the list is Brazil, where the richest fifth has income about 25 times that of the poorest fifth. Although all countries have substantial inequality in income, the degree of inequality is not the same everywhere.

When countries are ranked by inequality, the United States ends up slightly behind the middle of the pack. Compared to other economically advanced countries, such as Germany and Canada, the United States has substantial inequality. But the United States has a more equal income distribution than many developing countries, such as Chile and Brazil.

THE POVERTY RATE

A commonly used gauge of the distribution of income is the poverty rate. The poverty rate is the percentage of the population whose family income falls below an absolute level called the poverty line. The poverty line is set by the federal government at roughly three times the cost of providing an adequate diet. This line is adjusted every year to account for changes in the level of prices, and it depends on family size.

To get some idea about what the poverty rate tells us, consider the data for 1998. In that year, the median family had an income of $47,469, and the poverty line for a family of four was $16,660. The poverty rate was 12.7 percent. In other words, 12.7 percent of the population were members of families with incomes below the poverty line for their family size.

Figure 20-1 shows the poverty rate since 1959, when the official data begin. You can see that the poverty rate fell from 22.4 percent in 1959 to a low of 11.1 percent in 1973. This decline is not surprising, for average income in the economy (adjusted

Figure 20-1

THE POVERTY RATE. The

poverty rate shows the percentage of the population with incomes below an absolute level called the poverty line.

Source: U.S. Bureau of the Census.

Percent of the
Population
below Poverty
Line
25
20
15						Poverty rate
10
5
0	1965	1970	1975	1980	1985	1990	1995 1998
1960