TOPIC 7 - Wage Structure

8/12/2019 TOPIC 7 - Wage Structure

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The Wage Distribution in the UnitedStates, 2002

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0 500 1,000 1,500 2,000 2,500 3,000

Weekly Earnings

P e r c e n t

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Facts About the Earnings

Distribution• Wage differentials exist due to

▫ Human capital investments that vary from

worker to worker▫ Age (young workers are still accumulatinghuman capital, older workers are collectingreturns from earlier investments

• There is a positive correlation between abilityand human capital investments, which“ stretches out ” wages in the population

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Wage Inequality• Social and political concerns : distribution of wages and poverty

• Increase in wage inequality: rising wages for the best paid workers outstrip wage increasesreceived by average or low paid workers

• Wages of best paid increases while the wages ofaverage workers/ poorest paid remains same ordeclining, increase insignificant proportion

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Measuring Inequality:

The Lorenz Curve and the GiniCoefficient

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0 0.2 0.4 0.6 0.8 1Share of households

S h a r e o f i n c o m e

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B

C

Perfect-equalityLorenz curve

ActualLorenz curve

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Measuring Inequality• Along the horizontal axis as shown, we plot the

cumulative percentage of households, starting at zeroand ending at 1 (equivalent to 100%), with workersranked by their wage level. The number 0.2 on the

horizontal axis would indicate the 20% of workers with the lowest wage levels.• The vertical axis measures the cumulative share of

total wages earned by workers, again starting at zero

and running to 1 (equivalent to 100%).• The 45-degree diagonal line AB is called the Perfect-Equality Lorenz Curve because along this line thecumulative percentage of workers ranked by income

equals the cumulative percentage of income earned.

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Measuring Inequality

• The Lorenz curve describing the actual incomedistribution lies below it.

• It plots the actual share of income going to each

fraction of the household (workforce).• This curve lies below the perfect-equality Lorenzcurve. This implies that incomes are not equallydistributed, and the poorest 20% of workers receive

less than 20% of earnings.• The ratio of the shaded area to the area in the

triangle ABC gives the Gini coefficient.

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Household Shares of AggregateIncome, by Fifths of the IncomeDistribution, 2001

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Trends in Wage Inequality

• The wage structure is defined as the array of wage rate paid to workers and the laws of supplyand demand determine the structure of wages inthe labor market.

• Increase in wage inequality encompassed anincrease in the wages of the top-paid workersrelative to the median and a fall in the wages of thepoorest paid workers relative to the median.

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Trends in Wage Inequality

• Women earn about 90% of what men earn• Data on official statistics such as household

earnings, employment, and unemployment in

most Pacific Island countries are unreliable.• Available data point to the same conclusions for

most countries about the widening wage gap between the top and bottom percentiles of the

wage distribution and therefore the risinginequality in the living standards and increase inpoverty.

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Causes of Increased Wage Inequality• The increased inequality seems to have been caused by changes in economic ‘fundamentals’ – therelative supply and demand model, implying theshifts in labor supply and labor demand curves.

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Relative Supply and Demand

Model• Used as a theoretical basis to explain and interpretempirical results.

• Suppose there are two types of workers in the labormarket: skilled and unskilled.

• Let ‘r’ be the wage ratio between skilled andunskilled (relative wage of skilled workers) and let‘p’ be the ratio of the number of skilled workers to

the number of unskilled workers (relativeemployment of skilled workers).• For simplicity, we assume that the relative supply

of skilled workers is relatively inelastic.

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Changes in the Wage StructureResulting from Shifts in Supply and

Demand

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Relative Supply and Demand Model * However, there has been a sizable increase in the

relative number of skilled workers and a rapid rise inthe relative wage of skilled workers

• In terms of our model, the only relevant reasoning to

explain the observed trend in wage inequality is thatas there was a dramatic increase in the relativesupply of skilled workers, the relative demand forskilled also rises, both curves shifting to the right.

• The relative demand for skilled workers was rising ata faster rate than the relative supply of skilled workers, reaching our final equilibrium at point C inthe diagram.

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Causes of shifts in the relativesupply of skilled workers

• Increased supply of high school dropoutsrelative to supply of high school graduates

• Slow growth in the relative supply of moreeducated workers

• Reducing the wage of high school dropouts and

less educated workers

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Causes of shifts in demand for skilledworkers

• Two main causes of rising demand for skilled workers

1. International trade2. Technological change .The impact of international trade and technological

change on the wage structure have contributed tothe rise in wage inequality in the 1980s and 1990s where wages were rising the fastest at the high wageend (highly skilled workers) and rising more slowlyor falling at the low wage end (unskilled workers)

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Changes in Labor Market Institutions• Labor market institutions such as trade unions,

government regulations, and internal labormarkets, have important effects on wage settingand the level of employment.

• Particular attention has been focused onminimum wage policy and the role of collective bargaining as the main institutional factorsdetermining wage inequality.

• Some studies have shown a close correlation between declining unionization rates and rising wage inequality.

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THE END

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TOPIC 7 - Wage Structure

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