Our aim in this is to employ simple economic principles in an attempt to explain why different people earn different salaries. We’ll discuss the human capital model, which emphasizes the importance of differences in personal characteristics. But our focus will be on why people with similar personal characteristics often earn sharply different incomes. Among the factors we will consider are labour unions, winner-take-all markets, discrimination, and the effect of nonwage conditions of employment. A labor force is the total number of employed and un-employed people in the economy.
It is one of the important inputs used in production of a good or a service. It comprises of people’s physical and mental talents and efforts. Wage and Salary Determination in Competitive Labour Markets2 Each specific category of labor has a demand curve and a supply curve. These curves intersect to determine both the equilibrium wage and the equilibrium quantity of employment for each category of labor. This equilibrium principle helps us to understand how wages will differ among workers with different levels of productive ability.
For example, an increase in the demand for a specific category of labor will generally increase both the equilibrium wage and the equilibrium quantity of employment in that category. Similarly, an increase in the supply of labor to a given occupation will tend to increase the level of employment and lower the wage rate in that occupation. In competitive labor markets, employers face pressure to pay each worker the value of his or her marginal product. When a firm can hire as many workers as it wishes at a given market wage, it should expand employment as long as the value of marginal product of labor exceeds the market wage.
MONOPSONY: The Lone Employer in a Labour Market3 The only buyer of labor services in its local labor market. The labor supply curve facing the company is now the labor supply curve for the market as a whole. In many ways the problem facing the monopsonist is similar to the one facing the monopolist in the market for a product. Because the monopolist’s demand curve is the same as the product demand curve for the market as a whole, the only way the monopolist can expand sales is by cutting price.
Similarly, because the supply curve of labor confronting the monopsonist is the supply curve for the labor market as a whole, the only way the monopsonist can hire additional workers is by offering higher wages. The monopsonist has an incentive to limit employment, much as the monopolist has an incentive to limit output. Unlike the perfectly competitive employer, who can hire as much labor as he wishes at the market wage, the monopsonist can expand employment only by offering higher wages.
And unlike the perfectly competitive employer, who continues hiring only until VMP equals the market wage, the monopsonist continues hiring until value of the marginal product equals marginal labor cost, which exceeds the market wage. The profit-maximizing employment level for the monopsonist is lower than the level that would maximize total economic surplus. Equilibrium in the Labour Market4 The demand for labor in a perfectly competitive labor market is the horizontal sum of each employer’s VMP (Value of Marginal Product) curve.
The supply curve of labor for an individual labor market is upward-sloping, even though the supply curve of labor for the economy as a whole may be vertical, or even downward-sloping. In each labor market, the demand and supply curves intersect to determine the equilibrium wage and level of employment. Human Capital Theory5 A theory of pay determination that says a worker’s wage will be proportional to his or her stock of human capital. Human capital an amalgam of factors such as education, training, experience, intelligence, energy, work habits, trustworthiness, initiative, and others that affect the value of a worker’s marginal product.
Some who compared the salaries of managers with MBAs to those of managers without MBAs might be tempted to conclude that the MBAs had reaped an enormous windfall. But their advantage appears less dramatic once we include the cost of acquiring the additional human capital. Trade/Labour Unions6 A trade union is an association of work-people formed to safe guard and improve the wage rates and working conditions of its members and more generally, to raise their status and promote their vocational interests.
It substitutes collective bargaining, thus strengthening the position of workers. Historically, the unionized hope that the union will provide a basis for confronting the monopsy power of employers with the collective power of workers. The main objectives of trade unions vary from country to country and from time to time. They normally include improvements in the wage rates and working conditions such as shorter hour, easier work rules, better fringe benefits, and better protection of workers against unfair practices, dismissal and victimization, and provision of their security.
Raising the vocational status of workers through greater participation in the formulation of the policy of the firm and the co-operation with the government in the furtherance of overall national economic policy are also some of their aims. Trade unions are monopolies of labor. However the actual power of a union depends on various factors such as the prevailing economic situation, whether there is full employment or massive employment.