Seventh Edition

Principles of
Economics

Wojciech Gerson (1831-1901)

N. Gregory Mankiw

CHAPTER Earnings and

9 Discrimination
In this chapter,
look for the answers to these questions

• How do wages compensate for differences in job

characteristics?
• Why do people with more education earn higher
wages?
• Why are wages sometimes above their
equilibrium values?
• Why is it difficult to measure discrimination?
• When might the market solve the problem of
discrimination? When might it not?
U.S. Median Weekly Earnings, Selected Occupations, 2010
Both Gender
Occupation Men Women
sexes gap
Chief executives $1949 $2217 $1598 38.7%
Lawyers 1757 1895 1461 29.7%
Physicians, surgeons 1975 2278 1618 40.8%
Architects & engineers 1255 1293 1040 24.3%
Management 1230 1414 1018 38.9%
Registered nurses 1055 1201 1039 15.6%
High school teachers 987 1035 962 7.6%
Counselors 808 780 818 –4.6%
Retail salespersons 527 651 421 54.6%
Waiters/waitresses 401 450 381 18.1%
All occupations $747 $824 $669 23.2%
Introduction
▪ In competitive markets, the wages workers earn
equal the value of their marginal products.
▪ There are many factors that affect productivity
and wages…

3
Compensating Differentials
▪ Compensating differential: a difference in
wages that arises to offset the nonmonetary
characteristics of different jobs
▪ These characteristics include unpleasantness,
difficulty, safety. Examples:
▪ Coal miners and fire fighters are paid more
than other workers with similar education
to compensate them for the extra risks.
▪ Night shift workers are paid more than day shift
to compensate for the lifestyle disruption of
working at night.
4
Ability, Effort, and Chance
▪ Greater ability or effort often command higher
pay. These traits increase workers’ marginal
products, make them more valuable to the firm.
▪ Wages also affected by chance
▪ E.g., new discoveries no one could have
predicted make some occupations obsolete,
increase demand in others.

5
Ability, Effort, and Chance
▪ Ability, effort, and chance are difficult to measure,
so it is hard to quantify their effects on wages.
▪ They are probably important, though,
since easily measurable characteristics
(education, age, etc.) account for less than half
of the variation in wages in our economy.

6
Case Study: The Benefits of Beauty
Research by Hamermesh and Biddle:
▪ People deemed more attractive than average
earn 5% more than people of average looks.
▪ Average-looking people earn 5–10% more
than below-average looking people.

7
Case Study: The Benefits of Beauty
Hypotheses:
1. Good looks matter for productivity
▪ In jobs where appearance is important,
attractive workers are more valuable to the
firm, command higher pay.
2. Good looks indirectly related to ability
▪ People who make an effort to project an
attractive appearance may be smarter or
more competent in other ways.
3. Discrimination

8
The Superstar Phenomenon
▪ Superstars like Johnny Depp, Beyoncé earn
many times more than average in their fields.
▪ The best plumbers or carpenters do not.
▪ 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
allows the best producer to supply every
customer at a low cost.
9
Human Capital
▪ Human capital: the accumulation of
investments in people, such as education and
on-the-job training
▪ Human capital affects productivity, and thus
labor demand and wages.

10
Weekly Earnings of Full-Time Employed
Persons Age 25+ by Education, 2012:Q4

Educational Median weekly

attainment earnings

Less than H.S. $ 478

H.S. diploma 647

Some college or
752
Associate degree
Bachelor’s degree 1,071

Advanced degree 1,379

11
 The Increasing Value of Skills
The earnings gap between
college-educated and
non-college-educated workers
has widened in recent decades.

Percentage difference in annual

earnings for college graduates
© michaeljung/Shutterstock.com
vs. high school diploma
1980 2012
Men 44% 69%
Women 35% 64%
12
The Increasing Value of Skills
Two hypotheses:
1. International trade
Rising exports of goods made with skilled labor,
rising imports of goods made with unskilled labor.
2. Skill-biased technological change
New technologies have increased demand for
skilled workers, reduced demand for unskilled
workers.
Difficult to determine which hypothesis
better explains the widening earnings gap;
probably both are important.
13
ACTIVE LEARNING 1
Discussion question
Suppose you were offered this choice:
A. Spend 4 years studying at the world’s best
university, but must keep your attendance there
a secret.
B. Get an official degree from the world’s best
university, but cannot actually study there.
Which do you think would enhance your future
earnings more?
The Signaling Theory of Education
An alternative view of education:
▪ Firms use education level to sort between
high-ability and low-ability workers.
▪ The difficulty of earning a college degree
demonstrates to prospective employers that
college graduates are highly capable.
▪ Yet, the education itself has no impact on
productivity or skills.
▪ Policy implication: Increasing general educational
attainment would not affect wages.
15
Reasons for Above-Equilibrium Wages
1. Minimum wage laws
The minimum wage may exceed the eq’m wage
of the least-skilled and experienced workers.

2. Unions
Union: a worker association that bargains with
employers over wages and working conditions
Unions use their market power to obtain higher
wages; most union workers earn 10–20% more
than similar nonunion workers.

16
Reasons for Above-Equilibrium Wages
3. Efficiency wages
Efficiency wages: above-equilibrium wages
paid by firms to increase worker productivity
Firms may pay higher wages to reduce turnover,
increase worker effort, or attract higher-quality
job applicants.

17
ACTIVE LEARNING 2
Explaining wage differentials
In each case, identify which worker would earn more
and use the concepts in this chapter to explain why.
A. The world’s best physical therapist or the world’s
best writer
B. A trucker who hauls produce or a trucker who
hauls hazardous waste
C. A graduate of an Ivy League college or an equally
intelligent & capable graduate of a state university
D. Someone who graduated from a state university
with a 3.7 GPA or someone who graduated from
the same university with a 2.4 GPA
ACTIVE LEARNING 2
Answers
A. The best physical therapist on the planet or
the best writer on the planet
The superstar phenomenon:
The best writer can service many more customers
than the best physical therapist.
B. A trucker who hauls produce or a trucker who hauls
hazardous waste from nuclear power plants
Compensating differentials:
The hazardous waste hauler earns more to
compensate for the higher risks.
ACTIVE LEARNING 2
Answers
C. A graduate of an Ivy League college or an equally
intelligent & capable graduate of a state university
The signaling theory of education:
Employers assume the Ivy League grad has more
ability than the state university grad.
D. Someone who graduated from a state university
with a 3.7 GPA, or someone who graduated from
the same university with a 2.4 GPA
The human capital theory of education:
A higher GPA reflects greater learning, which leads
to higher productivity and wages.
The Economics of Discrimination
▪ Discrimination: the offering of different
opportunities to similar individuals who differ
only by race, ethnicity, gender, or other personal
characteristics

21
 Measuring Labor-Market Discrimination
▪ Median earnings of full-time U.S. workers, 2012:
▪ White males earn 27% more than white
females.
▪ White males earn 33% more than black males.
▪ Taken at face value, these differences look like
evidence that employers discriminate.
▪ But there are many possible explanations for
wage differences besides discrimination;
the data above do not control for differences
in other factors that affect wages.
22
 Measuring Labor-Market Discrimination
Differences in human capital among groups:
▪ White males 75% more likely to have college degree
than black males
▪ White males 11% more likely to have graduate degree
than white females
▪ Women have less on-the-job experience than men
▪ Public schools in many predominantly black areas are
of lower quality (e.g., funding, class sizes)
There may well be discrimination in access to
education, but this problem occurs long before workers
enter the labor force.
23
 Measuring Labor-Market Discrimination
Recent study by Bertrand and Mullainathan finds
evidence of labor-market discrimination:
▪ 5000 fake résumés sent in response to
“help wanted” ads.
▪ Half had names more common among blacks,
like Lakisha Washington or Jamal Jones.
The other half had names common among whites,
like Emily Walsh or Greg Baker.
Otherwise, the résumés were the same.
▪ The white names received 50% more calls from
interested employers than the black names.
24
Discrimination by Employers
▪ Competitive markets provide a natural remedy
for employer discrimination:
The profit motive…

25
 Discrimination by Employers
Suppose
The some firms
discriminating
non-discriminating
Result: Demand for discriminate
firms firms
female against
will workers
begin
can hire lose female
to increases,
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cost advantage
workers and economic
wages profits,
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Result:attract
A wage entry of other non-discriminating firms.
differential.
Female workers Male workers
WF WM
SF SM

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26
Discrimination by Consumers
▪ Discrimination by consumers may result in
discriminatory wage differentials.
▪ Suppose firms care only about maximizing
profits, but customers prefer being served by
whites.
▪ Then firms have an incentive to hire white
workers, even if non-whites are willing to work
for lower wages.

27
Discrimination by Governments
▪ Some government policies mandate
discriminatory practices.
▪ apartheid in South Africa before 1994
▪ early 20th century U.S. laws requiring
segregation in buses and streetcars
▪ Such policies prevent the market from correcting
discriminatory wage differentials.

28
CONCLUSION
▪ In competitive markets, workers are paid a wage
that equals the value of their marginal products.
▪ Many factors affect the value of marginal products
and equilibrium wages.
▪ The profit motive can correct discrimination by
employers, but not discrimination by customers or
discriminatory policies of governments.
▪ Even without discrimination, the distribution of
income may not be equitable or desirable.
We explore this topic in the next chapter.
29
Summary
• Other things equal, wage differences
compensate workers for job attributes: The
harder or less pleasant a job, the more a worker
is compensated.
• Workers with more human capital are more
productive and command higher wages than
workers with less human capital.
• Workers with college degrees may get better job
offers because the degree signals high natural
ability to employers.
Summary
• Wages also may differ with natural ability, effort,
and chance.
• Wages are sometimes above their equilibrium
levels, due to minimum wage laws, the market
power of labor unions, and efficiency wages.
• Some differences in earnings are due to
discrimination on the basis of race or other
characteristics. Measuring the amount of
discrimination is difficult, though.
Summary
• The profit motive tends to limit the impact of
employer discrimination on wages.
• Discrimination by consumers or governments
may lead to persisting wage differentials.