FMA - Income Distribution and Trends in the Labor Market Lesson

Income Distribution and Trends in the Labor Market Lesson

Wage Determination

Labor Markets - Minimum Wage Video

View the following video on labor markets and minimum wage. To make the video full screen, click the double arrows at the bottom right corner of the object.

The Role of Productivity

Payments to each of the resources is based on a variety of factors. First, and perhaps most significantly, payments are based on the marginal productivities of the factors. Factors of production with greater marginal productivities will earn higher wages. An increase in productivity increases the MRP and will shift the demand curve for the factor to the right, thereby increasing the wage rate for labor or rental price for land/capital. Of course, a decrease in productivity will have the opposite effect.

The Role of Human Capital

Payments Received for Each Factor of Production

Land Earns – Rent
Capital Earns – Interest
Labor Earns – Wages
Entrepreneur Earns – Profit Human capital is the totality of an individual's knowledge, skills, and experience. Specifically, for labor, human capital can be increased by pursuing additional education and training in a particular field. This includes earning additional degrees or participating in on-the-job training through an employer. The employee becomes a more valuable asset to a firm - in reality or in theory - and firms are willing to pay those workers a higher wage.

The Role of Compensating Wage Differentials

Compensating wage differentials come into play when a difference in wage exists because of the nature of a job performed. For example, underwater welders are often paid more than regular welders. A portion of this is perhaps due to the refined set of additional skills (human capital) needed to perform the work. However, the basic skills for either job are the same - welding. So, a portion of the higher pay that underwater welders receive is due to the additional danger those welders face in the day-to-day task of carrying out their jobs.

The Role of Discrimination in the Labor Market

Sadly, discrimination is still an issue the American worker must confront and it plays a significant role in the wage gap between men, women, and minorities. Significant gains have been made in terms of closing the wage gap between women/minorities and their white, male counterparts. The most recent estimates suggest that white women earn approximately $0.78 for every dollar earned by a white male. The situation is even more pronounced among minority women. Typically, they earn between $0.55 and $0.65 for every dollar. This gap only improves slightly for male minorities. Anti-discrimination laws have helped close this gap over the past 50 years.

Gender Pay Gap

Bar Graph

X-Axis – Number of Dollars
Y-Axis
Total – Men $819, Women $657
White – Men $845, Women $669
Black or African-American - Men $621, Women $582
Asian - Men $952, Women $779
Hispanic or Latino Ethnicity - Men $569, Women $509

Data for Men shown in blue
Data for Women shown in Green

The Role of Unions

The popularity of unions has waxed and waned over the years. Union membership has generally been decreasing over the last forty years. Unions have, however, had significant influence over the wages earned in particular industries and occupations.

There are two main types of unions - industrial unions and craft unions. Industrial unions, such as the American Federation of Labor, promote the economic well-being of all members employed within a particular industry (from the secretary to the worker in the plant). Craft unions, such as historically known Knights of Labor, promote the economic well-being of workers performing a particular type of job.

The primary goal of a union is to increase the pay rate and/or working conditions for members. These goals are often accomplished by a combination of strategies. Given that demand for labor is a derived demand, unions frequently promote the demand for the products produced by union members. This results in the value of the worker (the MRP) increasing, the demand for that labor to increase, and justifying a higher wage. Of course, unions can also approach wage rates from the supply side of the market. Limiting the supply of a particular type of labor, through licensing requirements or other means, would shift the labor supply curve to the left and force a higher equilibrium wage rate. Finally, collective bargaining can result in higher wages for union members.

Impact of Collective Bargaining: Unions form a sort of monopoly power over the supply of labor in a particular industry. As such, the collective voice of many often has more influence than the voice of just a few workers. Collective bargaining involves negotiations between the union and management to increase wages, enhance fringe benefits, and improve working conditions. Of course, if negotiations fail, picketing and strikes can result. To see the power of the union, we must consider the case of a bilateral monopoly. A bilateral monopoly is a market in which there is a single seller (in this case, the union) and a single buyer (the firm).

Bilateral Monopoly Graph

X-Axis – Quantity of Labor
Y-Axis – Wage

The firm will hire Q workers and would like to pay a wage equal to "Firm Wage" found on the labor supply curve. The union would prefer the firm to pay a wage equal to the MCL at the quantity Q. Collective bargaining negotiations will result in the wage rate existing somewhere between these two dollar amounts.

Income Distribution

The equitable distribution of income can vary from one economy to another. Growing income inequality is a major concern for many economies around the world. It can be represented through the use of the Lorenz curve and the Gini Coefficient.

Income and Wealth Inequality Video

View the following video on income and wealth inequality. To make the video full screen, click the double arrows at the bottom right corner of the object.

Measuring Income Distribution

Households are divided into quintiles (where 100% of households are divided equally into fifths or categories containing 20% of households). If income in the economy was evenly divided between each quintile, perfect income distribution would result. That is, each quintile would account for 20% of a nation's wealth. Income distribution can be graphed using the Lorenz curve. Perfect income distribution would be represented by a 45° line. If, in fact, incomes were evenly distributed in a nation, the Lorenz curve would lie on top of the 45° line. As the Lorenz curve moves further and further below the 45° line, income inequality is increasing. The degree of income inequality, the Gini Coefficient, can be calculated by dividing the area between the 45° line and the Lorenz curve by the total area underneath the line of perfect equality. The Gini Coefficient ranges from 0 (perfect equality) to 1 (perfect inequality). Lorenz Curve Graph - Income Concentration, 2007

X-Axis – Cumulative Share of Population
Y-Axis – Cumulative Share of Income (Percent)

Two curves shown - Line of Perfect Income Equality and Market Income

Quintile	% of Market Income	Cumulative % Market Income
Lowest 20%	2%	2%
2nd	7%	9%
3rd	12%	21%
4th	19%	40%
Highest	60%	100%

It's important to note that the information presented in the chart and graph pertains to market income which has not been modified for taxes and transfer payments. Taxation and transfer can result in reducing income inequality, but those topics will be explored in the module on the role of government.

Global Income Distribution
Image of the world map with colors representing the global income distribution.

Gini Index (Income Equality = 0)

Dark green 25-30
Lighter Green 30-35
Lightest Green = 35-40
Pink = 40-45
Dark Pink = 45-50
Bright Red – 50-55
Dark Red – 55-60
Very Dark Red – 60-66
Gray – No Data

IMAGES CREATED BY GAVS (Images 1 and 2 - Image from freepik.com and modified by GAVS; Image 5 - Global Income Distribution -Image from Wikimedia Commons and modified by GAVS)