395
Earnings and
Discrimination
I
n the United States today, the typical physician earns about $200,000 a year, the
typical police officer about $60,000, and the typical fast-food cook about $20,000.
These examples illustrate the large differences in earnings that are so common
in our economy. The differences explain why some people live in mansions, ride
in limousines, and vacation on the French Riviera, while other people live in small
apartments, ride the bus, and vacation in their own backyards.
Why do earnings vary so much from person to person? Chapter 18, which
developed the basic neoclassical theory of the labor market, offers an answer to
this question. There we saw that wages are governed by labor supply and
labor demand. Labor demand, in turn, reflects the marginal productivity of
labor. In equilibrium, each worker is paid the value of her marginal contribution
to the economy’s production of goods and services.
This theory of the labor market, though widely accepted by economists, is
only the beginning of the story. To understand the wide variation in earnings
CHAPTER
19
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396 PARTVI THE ECONOMICS OF LABOR MARKETS
that we observe, we must go beyond this general framework and examine more
precisely what determines the supply and demand for different types of labor.
That is our goal in this chapter.
19-1 Some Determinants of Equilibrium Wages
Workers differ from one another in many ways. Jobs also have differing characteristics—both
in terms of the wages they pay and in terms of their nonmonetary
attributes. In this section, we consider how the characteristics of jobs and workers
affect labor supply, labor demand, and equilibrium wages.
19-1a Compensating Differentials
When a worker is deciding whether to take a job, the wage is only one of many
job attributes that the worker takes into account. Some jobs are easy, fun, and safe,
while others are hard, dull, and dangerous. The better the job as gauged by these
nonmonetary characteristics, the more people there are who are willing to do the
job at any given wage. In other words, the supply of labor for easy, fun, and safe
jobs is greater than the supply of labor for hard, dull, and dangerous jobs. As a
result, “good” jobs will tend to have lower equilibrium wages than “bad” jobs.
For example, imagine you are looking for a summer job in a local beach community.
Two kinds of jobs are available. You can take a job as a beach-badge
checker, or you can take a job as a garbage collector. The beach-badge checkers
take leisurely strolls along the beach during the day and check to make sure the
tourists have bought the required beach permits. The garbage collectors wake up
before dawn to drive dirty, noisy trucks around town to pick up garbage. Which
job would you want? Most people would prefer the beach job if the wages were
the same. To induce people to become garbage collectors, the town has to offer
higher wages to garbage collectors than to beach-badge checkers.
Economists use the term compensating differential to refer to a difference in
wages that arises from nonmonetary characteristics of different jobs. Compensating
differentials are prevalent in the economy. Here are some examples:
• Coal miners are paid more than other workers with similar levels of education.
Their higher wage compensates them for the dirty and dangerous nature
of coal mining, as well as the long-term health problems that coal miners
experience.
• Workers who work the night shift at factories are paid more than similar
workers who work the day shift. The higher wage compensates them for
having to work at night and sleep during the day, a lifestyle that most people
find undesirable.
• Professors are paid less than lawyers and doctors, who have similar amounts
of education. The higher wages of lawyers and doctors compensate them for
missing out on the great intellectual and personal satisfaction that professors’
jobs offer. (Indeed, teaching economics is so much fun that it is surprising that
economics professors are paid anything at all!)
19-1b Human Capital
As we discussed in the previous chapter, the word capital usually refers to an economy’s
stock of equipment and structures. The capital stock includes the farmer’s
compensating differential
a difference in wages
that arises to offset
the nonmonetary
characteristics of
different jobs
“On the one hand, I know
I could make more money
if I left public service for
the private sector, but, on
the other hand, I couldn’t
chop off heads.”
RobertMankoff/TheNewYorkerCollection/
www.cartoonbank.com
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CHAPTER 19 EARNINGS AND DISCRIMINATION 397
tractor, the manufacturer’s factory, and the teacher’s chalkboard. The essence of
capital is that it is a factor of production that itself has been produced.
There is another type of capital that, while less tangible than physical capital,
is just as important to the economy’s production. Human capital is the accumulation
of investments in people. The most important type of human capital is education.
Like all forms of capital, education represents an expenditure of resources
at one time to raise productivity in the future. But unlike an investment in other
forms of capital, an investment in education is tied to a specific person, and this
linkage is what makes it human capital.
Not surprisingly, workers with more human capital earn more on average
than those with less human capital. College graduates in the United States, for
example, earn almost twice as much as those workers who end their education
with a high school diploma. This large difference has been documented in many
countries around the world. It tends to be even larger in less developed countries,
where educated workers are in scarce supply.
From the perspective of supply and demand it is easy to see why education
raises wages. Firms—the demanders of labor—are willing to pay more for
highly educated workers because these workers have higher marginal products.
Workers—the suppliers of labor—are willing to pay the cost of becoming educated
only if there is a reward for doing so. In essence, the difference in wages
between highly educated workers and less educated workers may be considered
a compensating differential for the cost of becoming educated.
human capital
the accumulation of
investments in people,
such as education and
on-the-job training
The Increasing Value of Skills
“The rich get richer, and the poor get poorer.” Like many adages, this
one is not always true, but it has been in recent years. Many studies have
documented that the earnings gap between workers with high skills and
workers with low skills has increased over the past several decades.
Table 1 presents data on the average earnings of college graduates and of high
school graduates without any additional education. These data show the increase
in the financial reward from education. In 1975, a man on average earned 42 percent
more with a college degree than without one; by 2011, this figure had risen to
75 percent. For a woman, the reward for attending college rose from a 35 percent
increase in earnings in 1975 to an 81 percent increase in 2011. The incentive to stay
in school is as great today as it has ever been.
Why has the gap in earnings between skilled and unskilled workers widened
in recent years? No one knows for sure, but economists have proposed two
hypotheses to explain this trend. Both hypotheses suggest that the demand for
skilled labor has risen over time relative to the demand for unskilled labor. The
shift in demand has led to a corresponding change in the wages of both groups,
which in turn has led to greater inequality.
The first hypothesis is that international trade has altered the relative demand
for skilled and unskilled labor. In recent years, the amount of trade with other
countries has increased substantially. As a percentage of total U.S. production of
goods and services, imports have risen from 5 percent in 1970 to 18 percent in
2011, and exports have risen from 6 percent in 1970 to 14 percent in 2011. Because
unskilled labor is plentiful and cheap in many foreign countries, the United States
tends to import goods produced with unskilled labor and export goods produced
with skilled labor. Thus, when international trade expands, the domestic demand
for skilled labor rises and the domestic demand for unskilled labor falls.
case
study
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398 PARTVI THE ECONOMICS OF LABOR MARKETS
Average Annual Earnings by
Educational Attainment
College graduates have
always earned more than
workers without the benefit
of college, but the salary gap
has grown even larger over
the past few decades.
TABLE 1 1975 2011
Men
High school, no college $48,720 $46,038
College graduates $69,146 $80,508
Percent extra for college grads +42% +75%
Women
High school, no college $28,066 $32,249
College graduates $37,804 $58,229
Percent extra for college grads +35% +81%
Note: Earnings data are adjusted for inflation and are expressed in 2011 dollars. Data apply to full-time,
year-round workers age 18 and over. Data for college graduates exclude workers with additional schooling
beyond college, such as a master’s degree or Ph.D.
Source: U.S. Census Bureau and author’s calculations.
Regardless of the Cost,
College Still Matters
By Michael Greenstone and Adam Looney
As America continues its recovery from
the Great Recession, there is an ongoing
debate in the media and among policymakers
about the value of a college degree in today’s
economic climate. One issue that is receiving
a significant amount of attention is the rising
cost of college. Indeed, tuition has increased
by almost 50 percent in the last 30 years,
prompting some people to ask whether college
is still worth the price of admission.
In this month’s analysis, The Hamilton
Project confirms its previous findings that the
returns to college attendance are much higher
than other investments, such as stocks, bonds,
and real estate. We also find that the returns
to college have been largely constant over the
last 35 years, indicating that the rising tuition
costs have been offset by the increased earnings
premium for college graduates. . . .
In most respects, a college degree has
never been more valuable. Recent college
graduates earn more money and have an
easier time finding employment than their
peers who only have a high school diploma.
What may be less intuitive is that these gaps
have been growing in recent years. A young
college graduate earned about $4,000 more
per year in the 1980s, adjusting for inflation,
than someone of the same age who did not
attend college (averaged across the entire
population, not just those in the workforce).
Over the last three decades, that figure has
climbed to $12,000 per year.
Differences in employment rates between
college graduates and non-graduates have
not demonstrated as clear of a trend over
this period, with one key exception. In recent
years—particularly in the aftermath of the
Great Recession—college has become an
increasingly important determinant of one’s
employment status. Today, a college graduate
is almost 20 percentage points more likely to
be employed than someone with only a high
school diploma. This “employment gap”
between college and high school graduates is
the largest in our nation’s history. . . .
While the evidence is clear about the lifelong
value of more education, skeptics are
increasingly pointing to rising tuition costs to
claim that college is not as sound of an investment
as it once was. And it is true that tuition
has increased significantly over the past few
decades. In 1980, it cost an average of about
Higher Education as
an Investment
Is a college degree a good investment compared with, say, stocks and
bonds? According to the Hamilton Project, a research effort run by a
prominent Washington think tank, the answer is a resounding “yes.”
IN THE NEWS
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CHAPTER 19 EARNINGS AND DISCRIMINATION 399
$56,000 (adjusting for inflation) to attend a
university for four years. This figure includes
tuition, fees, and the “opportunity cost,” or
income one foregoes to attend school instead
of holding a job. (This figure excludes room
and board: one must eat and sleep whether
she is in college or not.) In 2010, four years
of college cost more than $82,000, a nearly
50 percent increase over that 30-year period.
This increase in tuition is based on calculations
from the National Center for Education
Statistics but it may overstate the rise in the
costs of college. First, this rise in tuition does
not account for recent increases in financial
aid. Thus, while the sticker price of college
may have gone up, it is unclear to what extent
the cost to students and their families has
increased. Indeed, according to the College
Board, the actual cost of a four-year degree
has remained relatively constant over the last
15 years.
Regardless of the magnitude of the exact
increase in tuition, a sole focus on the cost of
college is misleading because it only tells half
of the story. Specifically, the monetary benefits
of a college degree have increased dramatically
over the last few decades. An individual
who entered college in 1980 could expect to
earn about $260,000 more over the course
of her life compared to someone who received
only a high school diploma. In contrast, for
someone starting college in 2010, the expected
lifetime increase in earnings relative to a high
school graduate was more than $450,000.
These estimates are adjusted both for inflation
and the fact that most of this additional income
will come much later in a graduate’s life.
Even if we assume that all students actually
pay tuition at the published rates,
the bottom line is this: while college may be
50 percent more expensive now than it was 30
years ago, the increase to lifetime earnings
that a college degree brings is 75 percent
higher. In short, the cost of college is growing,
but the benefits of college—and, by extension,
the cost of not going to college—are
growing even faster.
The returns to an investment in a college
education, therefore, are high. The Hamilton
Project estimated that investing in a four-year
degree yields a return of above 15 percent.
While this is down slightly from almost
18 percent in the late ’90s, attending college
remains one of the best ways one can invest
her money. The return to college is more than
double the average return over the last 60 years
experienced in the stock market (6.8 percent),
and more than five times the return to investments
in corporate bonds (2.9 percent), gold
(2.3 percent), long-term government bonds
(2.2 percent), or housing (0.4 percent).
The cost of college can be daunting for
many families, but it is precisely because
college is such a sound investment that
there is an important role for government to
ensure that loan programs are plentiful and
accessible. The nation and the economy are
strengthened when college attendance is
determined by students’ abilities, not their
families’ financial background. Indeed, it is
not just the direct recipients of these loans
that benefit from the increased number of
Americans who are able to go to college. One
recent study showed that even individuals
with only a high school diploma earn more
when they live in cities populated with more
college graduates. More education is not just
good for individuals; it’s a good investment
for the broader community.
Source: The Hamilton Project at the Brookings Institution,
October 5, 2012.
The second hypothesis is that changes in technology have altered the relative
demand for skilled and unskilled labor. Consider, for instance, the introduction
of computers. Computers raise the demand for skilled workers who can use the
new machines and reduce the demand for the unskilled workers whose jobs are
replaced by the computers. For example, many companies now rely more on computer
databases, and less on filing cabinets, to keep business records. This change
raises the demand for computer programmers and reduces the demand for filing
clerks. Thus, as more firms use computers, the demand for skilled labor rises and
the demand for unskilled labor falls.
Economists have found it difficult to gauge the validity of these two hypotheses.
It is possible that both are true: Increasing international trade and technological
change may share responsibility for the increasing income inequality we have
observed in recent decades. In the next chapter, we discuss the issue of increasing
inequality in more detail.
19-1c Ability, Effort, and Chance
Why do major league baseball players get paid more than minor league players?
Certainly, the higher wage is not a compensating differential. Playing in the
major leagues is not a less pleasant job than playing in the minor leagues; in fact,
the opposite is true. The major leagues do not require more years of schooling or
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400 PARTVI THE ECONOMICS OF LABOR MARKETS
more experience. To a large extent, players in the major leagues earn more just
because they have greater natural ability.
Natural ability is important for workers in all occupations. Because of heredity
and upbringing, people differ in their physical and mental attributes. Some people
are strong, others weak. Some people are smart, others less so. Some people
are outgoing, others awkward in social situations. These and many other personal
characteristics determine how productive workers are and, therefore, play a role
in determining the wages they earn.
Closely related to ability is effort. Some people work hard; others are lazy. We
should not be surprised to find that those who work hard are more productive
and earn higher wages. To some extent, firms reward workers directly by paying
people based on what they produce. Salespeople, for instance, are often paid
a percentage of the sales they make. At other times, hard work is rewarded less
directly in the form of a higher annual salary or a bonus.
Chance also plays a role in determining wages. If a person attended a trade
school to learn how to repair televisions with vacuum tubes and then found this
skill made obsolete by the invention of solid-state electronics, she would end up
earning a low wage compared to others with similar years of training. The low
wage of this worker is due to chance—a phenomenon that economists recognize
but do not shed much light on.
How important are ability, effort, and chance in determining wages? It is hard
to say because these factors are difficult to measure. But indirect evidence suggests
that they are very important. When labor economists study wages, they
relate a worker’s wage to those variables that can be measured, such as years of
schooling, years of experience, age, and job characteristics. All these measured
variables affect a worker’s wage as theory predicts, but they account for less than
half of the variation in wages in our economy. Because so much of the variation in
wages is left unexplained, omitted variables, including ability, effort, and chance,
must play an important role.
The Benefits of Beauty
People differ in many ways, one of which is physical attractiveness.
The actor Ryan Gosling, for instance, is a handsome man. In part for this
reason, his movies attract large audiences. Not surprisingly, the large audiences
mean a large income for Mr. Gosling.
How prevalent are the economic benefits of beauty? Labor economists Daniel
Hamermesh and Jeff Biddle tried to answer this question in a study published in
the December 1994 issue of the American Economic Review. Hamermesh and Biddle
examined data from surveys of individuals in the United States and Canada. The
interviewers who conducted the survey were asked to rate each respondent’s
physical appearance. Hamermesh and Biddle then examined how much the
wages of the respondents depended on the standard determinants—education,
experience, and so on—and how much they depended on physical appearance.
Hamermesh and Biddle found that beauty pays. People who are deemed more
attractive than average earn 5 percent more than people of average looks, and
people of average looks earn 5 to 10 percent more than people considered less
attractive than average. Similar results were found for men and women.
What explains these differences in wages? There are several ways to interpret
the “beauty premium.”
case
study
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CHAPTER 19 EARNINGS AND DISCRIMINATION 401
19-1d An Alternative View of Education: Signaling
Earlier we discussed the human-capital view of education, according to which
schooling raises workers’ wages because it makes them more productive.
Although this view is widely accepted, some economists have proposed an alternative
theory, which emphasizes that firms use educational attainment as a way
of sorting between high-ability and low-ability workers. According to this alternative
view, when people earn a college degree, for instance, they do not become
more productive, but they do signal their high ability to prospective employers.
Because it is easier for high-ability people to earn a college degree than it is for
low-ability people, more high-ability people get college degrees. As a result, it is
rational for firms to interpret a college degree as a signal of ability.
The signaling theory of education is similar to the signaling theory of
advertising discussed in Chapter 16. In the signaling theory of advertising, the
advertisement itself contains no real information, but the firm signals the quality
of its product to consumers by its willingness to spend money on advertising.
In the signaling theory of education, schooling has no real productivity benefit,
but the worker signals her innate productivity to employers by her willingness to
spend years at school. In both cases, an action is being taken not for its intrinsic
benefit but because the willingness to take that action conveys private information
to someone observing it.
Thus, we now have two views of education: the human-capital theory and
the signaling theory. Both views can explain why more educated workers tend
to earn more than less educated workers. According to the human-capital view,
education makes workers more productive; according to the signaling view, education
is correlated with natural ability. But the two views have radically different
predictions for the effects of policies that aim to increase educational attainment.
According to the human-capital view, increasing educational levels for all workers
would raise all workers’ productivity and thereby their wages. According to the
signaling view, education does not enhance productivity, so raising all workers’
educational levels would not affect wages.
Most likely, the truth lies somewhere between these two extremes. The benefits
to education are probably a combination of the productivity-enhancing effects of
human capital and the productivity-revealing effects of signaling. The relative
size of these two effects is an open question.
One interpretation is that good looks are themselves a type of innate ability
determining productivity and wages. Some people are born with the physical
attributes of a movie star; other people are not. Good looks are useful in any job in
which workers present themselves to the public—such as acting, sales, and waiting
on tables. In this case, an attractive worker is more valuable to the firm than
an unattractive worker. The firm’s willingness to pay more to attractive workers
reflects its customers’ preferences.
A second interpretation is that reported beauty is an indirect measure of other
types of ability. How attractive a person appears depends on more than just
heredity. It also depends on dress, hairstyle, personal demeanor, and other attributes
that a person can control. Perhaps a person who successfully projects an
attractive image in a survey interview is more likely to be an intelligent person
who succeeds at other tasks as well.
A third interpretation is that the beauty premium is a type of discrimination, a
topic to which we return later.
Good looks pay.
cinemafestival/Shutterstock.com
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402 PARTVI THE ECONOMICS OF LABOR MARKETS
19-1e The Superstar Phenomenon
Although most actors earn little and often take jobs as waiters to support themselves,
Leonardo DiCaprio earns millions of dollars for each film he makes.
Similarly, while most people who play tennis do it for free as a hobby, Maria
Sharapova earns millions on the pro tour. DiCaprio and Sharapova are superstars
in their fields, and their great public appeal is reflected in astronomical incomes.
Why do DiCaprio and Sharapova earn so much? It is not surprising that
incomes differ within occupations. Good carpenters earn more than mediocre carpenters,
and good plumbers earn more than mediocre plumbers. People vary in
ability and effort, and these differences lead to differences in income. Yet the best
carpenters and plumbers do not earn the many millions that are common among
the best actors and athletes. What explains the difference?
To understand the tremendous incomes of DiCaprio and Sharapova, we must
examine the special features of the markets in which they sell their services.
Superstars arise in markets that have two characteristics:
• Every customer in the market wants to enjoy the good supplied by the best
producer.
• The good is produced with a technology that makes it possible for the best
producer to supply every customer at low cost.
If Leonardo DiCaprio is the best actor around, then everyone will want to see
his next movie; seeing twice as many movies by an actor half as talented is not a
good substitute. Moreover, it is possible for everyone to enjoy a performance by
Leonardo DiCaprio. Because it is easy to make multiple copies of a film, DiCaprio
can provide his service to millions of people simultaneously. Similarly, because
tennis matches are broadcast on television, millions of fans can enjoy the extraordinary
athletic skills of Maria Sharapova.
We can now see why there are no superstar carpenters and plumbers. Other
things being equal, everyone prefers to employ the best carpenter, but a carpenter,
unlike a movie actor, can provide her services to only a limited number of customers.
Although the best carpenter will be able to command a somewhat higher
wage than the average carpenter, the average carpenter will still be able to earn a
good living.
19-1f Above-Equilibrium Wages: Minimum-Wage Laws,
Unions, and Efficiency Wages
Most analyses of wage differences among workers are based on the equilibrium
model of the labor market—that is, wages are assumed to adjust to balance labor
supply and labor demand. But this assumption does not always apply. For some
workers, wages are set above the level that brings supply and demand into equilibrium.
Let’s consider three reasons this might be so.
One reason for above-equilibrium wages is minimum-wage laws, as we first
saw in Chapter 6. Most workers in the economy are not affected by these laws
because their equilibrium wages are well above the legal minimum. But for some
workers, especially the least skilled and experienced, minimum-wage laws raise
wages above the level they would earn in an unregulated labor market.
A second reason that wages might rise above their equilibrium level is the market
power of labor unions. A union is a worker association that bargains with
employers over wages and working conditions. Unions often raise wages above
the level that would prevail in their absence perhaps because they can threaten
union
a worker association that
bargains with employers
over wages and working
conditions
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CHAPTER 19 EARNINGS AND DISCRIMINATION 403
to withhold labor from the firm by calling a strike. Studies suggest that union
workers earn about 10 to 20 percent more than similar, nonunion workers.
A third reason for above-equilibrium wages is suggested by the theory of
efficiency wages. This theory holds that a firm can find it profitable to pay high
wages because doing so increases the productivity of its workers. In particular,
high wages may reduce worker turnover, increase worker effort, and raise the
quality of workers who apply for jobs at the firm. If this theory is correct, then
some firms may choose to pay their workers more than they would normally earn.
Above-equilibrium wages, whether caused by minimum-wage laws, unions,
or efficiency wages, have similar effects on the labor market. In particular, pushing
a wage above the equilibrium level raises the quantity of labor supplied and
reduces the quantity of labor demanded. The result is a surplus of labor, or unemployment.
The study of unemployment and the public policies aimed to deal with
it is usually considered a topic within macroeconomics, so it goes beyond the
scope of this chapter. But it would be a mistake to ignore these issues completely
when analyzing earnings. Although most wage differences can be understood
while maintaining the assumption of equilibrium in the labor market, aboveequilibrium
wages play a role in some cases.
strike
the organized withdrawal
of labor from a firm by
a union
efficiency wages
above-equilibrium wages
paid by firms to increase
worker productivity
Quick Quiz Define compensating differential and give an example. • Give two reasons
why more educated workers earn more than less educated workers.
19-2 The Economics of Discrimination
Another source of differences in wages is discrimination. Discrimination occurs
when the marketplace offers different opportunities to similar individuals who
differ only by race, ethnic group, sex, age, or other personal characteristics.
Discrimination reflects some people’s prejudice against certain groups in society.
Discrimination is an emotionally charged topic that often generates heated debate,
but economists try to study the topic objectively to separate myth from reality.
19-2a Measuring Labor-Market Discrimination
How much does discrimination in labor markets affect the earnings of different
groups of workers? This question is important, but answering it is not easy.
There is no doubt that different groups of workers earn substantially different
wages, as Table 2 demonstrates. The median black man in the United States is paid
discrimination
the offering of different
opportunities to similar
individuals who differ
only by race, ethnic
group, sex, age, or other
personal characteristics
Median Annual Earnings
by Race and Sex
TABLE 2
White Black
Percent by Which Earnings
Are Lower for Black Workers
Men $50,070 $39,483 21%
Women $37,719 $33,501 11%
Percent by Which Earnings Are
Lower for Women Workers 25% 15%
Note: Earnings data are for the year 2011 and apply to full-time, year-round workers age 14 and over.
Source: U.S. Census Bureau.
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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
404 PARTVI THE ECONOMICS OF LABOR MARKETS
21 percent less than the median white man, and the median black woman is paid
11 percent less than the median white woman. The differences by sex are also significant.
The median white woman is paid 25 percent less than the median white
man, and the median black woman is paid 15 percent less than the median black
man. Taken at face value, these differentials look like evidence that employers discriminate
against blacks and women.
Yet there is a potential problem with this inference. Even in a labor market
free of discrimination, different people have different wages. People differ in the
amount of human capital they have and in the kinds of work they are able and
willing to do. The wage differences we observe in an economy are, to some extent,
attributable to the determinants of equilibrium wages we discussed in the preceding
section. Simply observing differences in wages among broad groups—whites
and blacks, men and women—does not prove that employers discriminate.
Consider, for example, the role of human capital. In 2011, among men age 25
and older, 32 percent of the white population had a college degree, compared with
18 percent of the black population. Among women age 25 and older, 31 percent of
the white population had a college degree, compared with 21 percent of the black
population. Thus, at least some of the difference between the wages of whites and
the wages of blacks can be traced to differences in educational attainment.
Moreover, human capital may be more important in explaining wage differentials
than years of schooling suggest. Historically, public schools in predominantly
black areas have been of lower quality—as measured by expenditure, class
size, and so on—than public schools in predominantly white areas. If we could
measure the quality as well as the quantity of education, the differences in human
capital among these groups would seem even larger.
Human capital acquired in the form of job experience can also help explain
wage differences. In particular, women are more likely to interrupt their careers
to raise children. Among the population aged 25 to 34 (when many people have
small children at home), only 75 percent of women are in the labor force, compared
to 90 percent of men. As a result, female workers, especially at older ages,
tend to have less job experience than male workers.
Yet another source of wage differences is compensating differentials. Men
and women do not always choose the same type of work, and this fact may help
explain some of the earnings differential between men and women. For example,
women are more likely to be secretaries, and men are more likely to be truck
drivers. The relative wages of secretaries and truck drivers depend in part on the
working conditions of each job. Because these nonmonetary aspects are hard to
measure, it is difficult to gauge the practical importance of compensating differentials
in explaining the wage differences that we observe.
In the end, the study of wage differences among groups does not establish any
clear conclusion about the prevalence of discrimination in U.S. labor markets.
Most economists believe that some of the observed wage differentials are attributable
to discrimination, but there is no consensus about how much. The only conclusion
about which economists are in consensus is a negative one: Because the
differences in average wages among groups in part reflect differences in human
capital and job characteristics, they do not by themselves say anything about how
much discrimination there is in the labor market.
Of course, differences in human capital among groups of workers may also
reflect a kind of discrimination. The less rigorous curriculums historically offered
to female students, for instance, can be considered a discriminatory practice.
Similarly, the inferior schools historically available to black students may be
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CHAPTER 19 EARNINGS AND DISCRIMINATION 405
traced to prejudice on the part of city councils and school boards. But this kind of
discrimination occurs long before the worker enters the labor market. In this case,
the disease is political, even if the symptom is economic.
Is Emily More Employable than Lakisha?
Although measuring the extent of discrimination from labor-market
outcomes is hard, some compelling evidence for the existence of such discrimination
comes from a creative “field experiment.” Economists Marianne
Bertrand and Sendhil Mullainathan answered more than 1,300 help-wanted
ads run in Boston and Chicago newspapers by sending in nearly 5,000 fake résumés.
Half of the résumés had names that were common in the African-American
community, such as Lakisha Washington or Jamal Jones. The other half had names
that were more common among the white population, such as Emily Walsh and
Greg Baker. Otherwise, the résumés were similar. The results of this experiment
were published in the American Economic Review in September 2004.
The researchers found large differences in how employers responded to the two
groups of résumés. Job applicants with white names received about 50 percent
more calls from interested employers than applicants with African-American
names. The study found that this discrimination occurred for all types of employers,
including those who claimed to be an “Equal Opportunity Employer” in their
help-wanted ads. The researchers concluded that “racial discrimination is still a
prominent feature of the labor market.”
case
study
19-2b Discrimination by Employers
Let’s now turn from measurement to the economic forces that lie behind discrimination
in labor markets. If one group in society receives a lower wage than
another group, even after controlling for human capital and job characteristics,
who is to blame for this differential?
The answer is not obvious. It might seem natural to blame employers for discriminatory
wage differences. After all, employers make the hiring decisions that
determine labor demand and wages. If some groups of workers earn lower wages
than they should, then it seems that employers are responsible. Yet many economists
are skeptical of this easy answer. They believe that competitive, market
economies provide a natural antidote to employer discrimination. That antidote is
called the profit motive.
Imagine an economy in which workers are differentiated by their hair color.
Blondes and brunettes have the same skills, experience, and work ethic. Yet
because of discrimination, employers prefer to hire workers with brunette hair.
Thus, the demand for blondes is lower than it otherwise would be. As a result,
blondes earn a lower wage than brunettes.
How long can this wage differential persist? In this economy, there is an easy
way for a firm to beat out its competitors: It can hire blonde workers. By hiring
blondes, a firm pays lower wages and thus has lower costs than firms that hire
brunettes. Over time, more and more “blonde” firms enter the market to take
advantage of this cost advantage. The existing “brunette” firms have higher costs
and, therefore, begin to lose money when faced with the new competitors. These
losses induce the brunette firms to go out of business. Eventually, the entry of
blonde firms and the exit of brunette firms cause the demand for blonde workers
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406 PARTVI THE ECONOMICS OF LABOR MARKETS
to rise and the demand for brunette workers to fall. This process continues until
the wage differential disappears.
Put simply, business owners who care only about making money are at an
advantage when competing against those who also care about discriminating. As
a result, firms that do not discriminate tend to replace those that do. In this way,
competitive markets have a natural remedy for employer discrimination.
Segregated Streetcars and the Profit Motive
In the early 20th century, streetcars in many southern cities were segregated
by race. White passengers sat in the front of the streetcars, and
black passengers sat in the back. What do you suppose caused and maintained
this discriminatory practice? And how was this practice viewed by the
firms that ran the streetcars?
In a 1986 article in the Journal of Economic History, economic historian Jennifer
Roback looked at these questions. Roback found that the segregation of races on
streetcars was the result of laws that required such segregation. Before these laws
were passed, racial discrimination in seating was rare. It was far more common to
segregate smokers and nonsmokers.
Moreover, the firms that ran the streetcars often opposed the laws requiring
racial segregation. Providing separate seating for different races raised the firms’
costs and reduced their profits. One railroad company manager complained to the
city council that, under the segregation laws, “the company has to haul around a
good deal of empty space.”
Here is how Roback describes the situation in one southern city:
The railroad company did not initiate the segregation policy and was not at all
eager to abide by it. State legislation, public agitation, and a threat to arrest the
president of the railroad were all required to induce them to separate the races
on their cars…. There is no indication that the management was motivated
by belief in civil rights or racial equality. The evidence indicates their primary
motives were economic; separation was costly…. Officials of the company may
or may not have disliked blacks, but they were not willing to forgo the profits
necessary to indulge such prejudice.
The story of southern streetcars illustrates a general lesson: Business owners
are usually more interested in making profits than in discriminating against a particular
group. When firms engage in discriminatory practices, the ultimate source
of the discrimination often lies not with the firms themselves but elsewhere. In
this particular case, the streetcar companies segregated whites and blacks because
discriminatory laws, which the companies opposed, required them to do so.
case
study
19-2c Discrimination by Customers and Governments
The profit motive is a strong force acting to eliminate discriminatory wage differentials,
but there are limits to its corrective abilities. Two important limiting
factors are customer preferences and government policies.
To see how customer preferences for discrimination can affect wages, consider
again our imaginary economy with blondes and brunettes. Suppose that restaurant
owners discriminate against blondes when hiring waiters. As a result, blonde
waiters earn lower wages than brunette waiters. In this case, a restaurant can open
up with blonde waiters and charge lower prices. If customers care only about the
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CHAPTER 19 EARNINGS AND DISCRIMINATION 407
quality and price of their meals, the discriminatory firms will be driven out of
business, and the wage differential will disappear.
On the other hand, it is possible that customers prefer being served by brunette
waiters. If this discriminatory preference is strong, the entry of blonde restaurants
need not succeed in eliminating the wage differential between brunettes
and blondes. That is, if customers have discriminatory preferences, a competitive
market is consistent with a discriminatory wage differential. An economy with
such discrimination would contain two types of restaurants. Blonde restaurants
hire blondes, have lower costs, and charge lower prices. Brunette restaurants hire
brunettes, have higher costs, and charge higher prices. Customers who did not
care about the hair color of their waiters would be attracted to the lower prices at
the blonde restaurants. Bigoted customers would go to the brunette restaurants
and would pay for their discriminatory preference in the form of higher prices.
Another way for discrimination to persist in competitive markets is for the
government to mandate discriminatory practices. If, for instance, the government
passed a law stating that blondes could wash dishes in restaurants but could not
work as waiters, then a wage differential could persist in a competitive market.
The example of segregated streetcars in the previous case study is one example of
government-mandated discrimination. Similarly, before South Africa abandoned
its formal policy of racial segregation called apartheid in 1990, blacks were prohibited
from working in some jobs. Discriminatory governments pass such laws
to suppress the normal equalizing force of free and competitive markets.
To sum up: Competitive markets contain a natural remedy for employer discrimination.
The entry of firms that care only about profit tends to eliminate discriminatory wage
differentials. These wage differentials persist in competitive markets only when customers
are willing to pay to maintain the discriminatory practice or when the government mandates
it.
Discrimination in Sports
As we have seen, measuring discrimination is often difficult. To determine
whether one group of workers is discriminated against, a researcher
must correct for differences in the productivity between that group and
other workers in the economy. Yet in most firms, it is difficult to measure a
particular worker’s contribution to the production of goods and services.
One type of firm in which such measurements are easier is the sports team.
Professional teams have many objective measures of productivity. In baseball, for
instance, we can measure a player’s batting average, the frequency of home runs,
the number of stolen bases, and so on.
Studies of sports teams suggest that racial discrimination has, in fact, been
common and that much of the blame lies with customers. One study, published in
the Journal of Labor Economics in 1988, examined the salaries of basketball players
and found that black players earned 20 percent less than white players of comparable
ability. The study also found that attendance at basketball games was larger
for teams with a greater proportion of white players. One interpretation of these
facts is that, at least at the time of the study, customer discrimination made black
players less profitable than white players for team owners. In the presence of such
customer discrimination, a discriminatory wage gap can persist, even if team
owners care only about profit.
A similar situation once existed for baseball players. A study using data from
the late 1960s showed that black players earned less than comparable white
case
study
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408 PARTVI THE ECONOMICS OF LABOR MARKETS
players. Moreover, fewer fans attended games pitched by blacks than games
pitched by whites, even though black pitchers had better records than white
pitchers. Studies of more recent salaries in baseball, however, have found no evidence
of discriminatory wage differentials.
Another study, published in the Quarterly Journal of Economics in 1990, examined
the market prices of old baseball cards. This study found similar evidence
of discrimination. The cards of black hitters sold for 10 percent less than the cards
of comparable white hitters, and the cards of black pitchers sold for 13 percent
less than the cards of comparable white pitchers. These results suggest customer
discrimination among baseball fans.
Quick Quiz Why is it hard to establish whether a group of workers is being discriminated
against? • Explain how profit-maximizing firms tend to eliminate discriminatory wage
differentials. • How might a discriminatory wage differential persist?
The Difference between
Men and Women,
Revisited: It’s about
Competition
By Hal R. Varian
Gender differences are a topic of endless
discussion for parents, teachers and
social scientists. . . . A noteworthy case in
point is a recent National Bureau of Economic
Research working paper by a Stanford economist,
Muriel Niederle, and Lise Vesterlund, a
University of Pittsburgh economist, titled, “Do
Women Shy Away From Competition? Do Men
Compete Too Much?”
It is widely noted that women are not well
represented in high-paying corporate jobs,
or in mathematics, science and engineering
jobs. As the authors observe, the “standard
economic explanations for such occupational
differences include preferences, ability and
discrimination.”
To this list the authors add a new factor:
attitudes toward competitive environments.
If men prefer more competitive environments
than women, then there will be more men
represented in areas where competition is
intense.
Of course, discussions of gender differences
of any sort can only be statements about
averages; it is clear that there are women who
thrive in competitive environments and men
who do not. Furthermore, attitudes toward
competition may be ingrained or a result of
factors like social stereotyping.
Is there any evidence that the hypothesis
is true? Do men really prefer more competitive
environments than women? One could
cite anecdote after anecdote, but the authors
took a much more direct approach: they ran
an experiment.
By using an experiment, the authors were
able to determine not only whether men and
women differ in their willingness to compete,
but more important, whether they differ in
their willingness to compete conditioned on
their actual performance.
The economists asked 80 subjects,
divided into groups of two women and
two men, to add up sets of five two-digit
Gender Differences
Economic research is shedding light on why men and women choose
different career paths.
IN THE NEWS
19-3 Conclusion
In competitive markets, workers earn a wage equal to the value of their marginal
contribution to the production of goods and services. There are, however, many
things that affect the value of the marginal product. Firms pay more for workers
who are more talented, more diligent, more experienced, and more educated
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CHAPTER 19 EARNINGS AND DISCRIMINATION 409
numbers for five minutes. The subjects performed
the task first on a piece-rate basis
(50 cents for each correct answer) and then
as a tournament (the person with the most
correct answers in each group received $2
per correct answer, while other participants
received nothing). Note that a subject with a
25 percent chance of being a winner in the
tournament received the same average payment
as in the piece-rate system.
All participants were told how many
problems they got right, but not their relative
performance. After completing the two tasks,
the subjects were asked to choose whether
they preferred a piece-rate system or a tournament
for the third set of problems.
There were several interesting findings in
this experiment. First, there were no differences
between men and women in their performance
under either compensation system. Despite
this, twice as many men selected the tournament
as women (75 percent versus 35 percent).
Even if one accounts for performance
by comparing only men and women with the
same number of correct answers, the women
have a 38 percent lower probability of choosing
the tournament compensation.
Why were the men much more likely to
choose the tournament? Perhaps it was because
they felt more confident about their abilities. The
data support this hypothesis, with 75 percent of
the men believing that they won their four-player
tournament, while 43 percent of the women
thought they were best in their group.
Though both groups were overconfident
about their performance, the men were much
more so…. The results of this experiment
are consistent with the finding by a Berkeley
finance professor, Terry Odean, that men
trade stocks excessively, apparently because
they (wrongly) feel that they have exceptional
ability to pick winners. Women trade less, but
do better on average, because they are more
likely to follow a buy-and-hold strategy.
The authors summarized their experimental
results by saying, “From a payoff-maximizing
perspective, high-performing women enter the
tournament too rarely, and low-performing men
enter the tournament too often.” The low-performing
men and the high-performing women
are both hurt by this behavior but, in this
experiment at least, the costs to the women
who did not choose the tournament when they
should have exceeded the costs to the men who
should have avoided the tournament.
One should not read too much into one
study. But if it is really true that women choose
occupations that involve less competition,
then one may well ask why. Sociobiologists
may suggest that such differences come
from genetic propensities; sociologists may
argue for differences in social roles and
expectations; developmental psychologists
may emphasize child-rearing practices. Whatever
the cause, Ms. Niederle and Ms. Vesterlund
have certainly raised a host of interesting
and important questions.
Mr. Varian is a professor emeritus at the
University of California at Berkeley and Chief
Economist at Google.
Source: New York Times, March 9, 2006.
because these workers are more productive. Firms pay less to those workers
against whom customers discriminate because these workers contribute less to
revenue.
The theory of the labor market we have developed in the last two chapters
explains why some workers earn higher wages than other workers. The theory
does not say that the resulting distribution of income is equal, fair, or desirable in
any way. That is the topic we take up in Chapter 20.
• Workers earn different wages for many reasons. To
some extent, wage differentials compensate workers
for job attributes. Other things being equal, workers in
hard, unpleasant jobs are paid more than workers
in easy, pleasant jobs.
• Workers with more human capital are paid more than
workers with less human capital. The return to accumulating
human capital is high and has increased over
the past several decades.
• 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 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 is
correct, then increasing the educational attainment of
all workers would not raise the overall level of wages.
SummarySummary
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410 PARTVI THE ECONOMICS OF LABOR MARKETS
Questions for Review
1. Why are coal miners paid more than other workers
with similar amounts of education?
2. In what sense is education a type of capital?
3. How might education raise a worker’s wage without
raising the worker’s productivity?
4. What conditions lead to highly compensated
superstars? Would you expect to see superstars in
dentistry? In music? Explain.
5. Give three reasons a worker’s wage might be above
the level that balances supply and demand.
6. What difficulties arise in deciding whether a group of
workers has a lower wage because of discrimination?
7. Do the forces of economic competition tend to exacerbate
or ameliorate discrimination based on race?
8. Give an example of how discrimination might persist
in a competitive market.
• Wages are sometimes pushed above the level that
brings supply and demand into balance. Three reasons
for above-equilibrium wages are minimum-wage
laws, unions, and efficiency wages.
• Some differences in earnings are attributable to discrimination
based on race, sex, or other factors.
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 reduce
discriminatory wage differentials. Discrimination persists
in competitive markets, however, if customers are
willing to pay more to discriminatory firms or if the
government passes laws requiring firms to discriminate.
compensating differential, p. 396
human capital, p. 397
union, p. 402
strike, p. 403
efficiency wages, p. 403
discrimination, p. 403
Key ConceptsKey Concepts
1. Ricky leaves his job as a high school math teacher and
returns to school to study the latest developments in
computer programming, after which he takes a higherpaying
job at a software firm. This is an example of
a. a compensating differential.
b. human capital.
c. signaling.
d. efficiency wages.
2. Lucy and Ethel work at a local department store. Lucy,
who greets customers as they arrive, is paid less than
Ethel, who cleans the bathrooms. This is an example of
a. a compensating differential.
b. human capital.
c. signaling.
d. efficiency wages.
3. Fred runs a small manufacturing company. He pays
his employees about twice what other firms in the area
pay, even though he could pay less and still recruit all
the workers he wants. He believes that higher wages
make his workers more loyal and hard-working. This
is an example of
a. a compensating differential.
b. human capital.
c. signaling.
d. efficiency wages.
4. A business consulting firm hires Vivian because she
was a math major in college. Her new job does not
require any of the mathematics she learned, but the
firm believes that anyone who can graduate with a
math degree must be very smart. This is an example of
a. a compensating differential.
b. human capital.
c. signaling.
d. efficiency wages.
5. Measuring how much discrimination affects labor
market outcomes is difficult because
a. data on wages are crucial but not readily available.
b. firms misreport the wages they pay to hide
discriminatory practices.
c. workers differ in their attributes and the types of
jobs they have.
d. the same minimum-wage law applies to workers in
all groups.
6. The forces of competition in markets with free entry
and exit tend to eliminate wage differentials that arise
from discrimination by
a. employers.
b. customers.
c. government.
d. all of the above.
Quick Check Multiple ChoiceQuick Check Multiple Choice
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CHAPTER 19 EARNINGS AND DISCRIMINATION 411
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, “subminimum”
wage for teenage workers. Give two reasons 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 why this might
occur.
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. Imagine that someone offered you a choice: You
could spend 4 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?
6. When recording devices were first invented more than
100 years ago, musicians could suddenly supply their
music to large audiences at low cost. How do you
suppose this development affected the income of the
best musicians? How do you suppose it affected the
income of average musicians?
7. A current debate in education is whether teachers
should be paid on a standard pay scale based solely
upon their years of training and teaching experience,
or whether part of their salary should be based upon
their performance (called “merit pay”).
a. Why might merit pay be desirable?
b. Who might be opposed to a system of merit pay?
c. What is a potential challenge of merit pay?
d. A related issue: Why might a school district decide
to pay teachers significantly more than the salaries
offered by surrounding districts?
8. When Alan Greenspan (who would later become
chairman of the Federal Reserve) ran an economic
consulting firm in the 1960s, he primarily hired female
economists. He once told the New York Times,
“I always valued men and women equally, and I
found that because others did not, good women
economists were cheaper than men.” Is Greenspan’s
behavior profit-maximizing? Is it admirable or
despicable? If more employers were like Greenspan,
what would happen to the wage differential between
men and women? Why might other economic consulting
firms at the time not have followed Greenspan’s
business strategy?
9. This chapter considers the economics of discrimination
by employers, customers, and governments.
Now consider discrimination by workers. Suppose
that some brunette workers do not like working with
blonde workers. Can this worker discrimination 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?
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Problems and ApplicationsProblems and Applications
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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.