4 0 8
PA R T S I X
T H E E C O N O M I C S O F L A B O R M A R K E T S
C A S E S T U D Y
PRODUCTIVITY
AND WAGES
One of the
Ten Principles of Economics
in Chapter 1 is that our standard of living
depends on our ability to produce goods and services. We can now see how this
principle works in the market for labor. In particular, our analysis of labor de-
mand shows that wages equal productivity as measured by the value of the
marginal product of labor. Put simply, highly productive workers are highly
paid, and less productive workers are less highly paid.
This lesson is key to understanding why workers today are better off than
workers in previous generations. Table 18-2 presents some data on growth in
productivity and growth in wages (adjusted for inflation). From 1959 to 1997,
productivity as measured by output per hour of work grew about 1.8 percent
per year; at this rate, productivity doubles about every 40 years. Over this pe-
riod, wages grew at a similar rate of 1.7 percent per year.
producers make greater profit, and apple pickers earn higher wages. When the
price of apples falls, apple producers earn smaller profit, and apple pickers earn
lower wages. This lesson is well known to workers in industries with highly
volatile prices. Workers in oil fields, for instance, know from experience that their
earnings are closely linked to the world price of crude oil.
From these examples, you should now have a good understanding of how
wages are set in competitive labor markets. Labor supply and labor demand to-
gether determine the equilibrium wage, and shifts in the supply or demand curve
for labor cause the equilibrium wage to change. At the same time, profit maxi-
mization by the firms that demand labor ensures that the equilibrium wage always
equals the value of the marginal product of labor.
Wage
(price of
labor)
W
1
W
2
0
Quantity of
Labor
L
1
L
2
Supply
Demand,
D
1
2. . . .
increases
the wage . . .
3. . . . and increases employment.
1. An increase in
labor demand . . .
D
2
F i g u r e 1 8 - 6
A S
HIFT IN
L
ABOR
D
EMAND
.
When labor demand increases
from
D
1
to
D
2
, perhaps because of
an increase in the price of the
firms’ output,
the equilibrium
wage rises from
W
1
to
W
2
, and
employment rises from
L
1
to
L
2
.
Again, the change in the wage
reflects a change in the value of
the marginal product of labor:
With
a higher output price, the
added output from an extra
worker is more valuable.
C H A P T E R 1 8
T H E M A R K E T S F O R T H E FA C T O R S O F P R O D U C T I O N
4 0 9
Table 18-2 also shows that, beginning around 1973, growth in productivity
slowed from 2.9 to 1.1 percent per year. This 1.8 percentage-point slowdown in
productivity coincided with a slowdown in wage growth of 1.9 percentage
points. Because of this productivity slowdown, workers in the 1980s and 1990s
did not experience the same rapid growth in living standards that their parents
enjoyed. A slowdown of 1.8 percentage points might not seem large, but accu-
mulated over many years, even a small change in a growth rate is significant. If
productivity and wages had grown at the same rate since 1973 as they did pre-
viously, workers’ earnings would now be about 50 percent higher than they are.
The link between productivity and wages also sheds light on international
experience. Table 18-3 presents some data on productivity growth and wage
growth for a representative group of countries, ranked in order of their produc-
tivity growth. Although these international data are far from precise, a close link
between the two variables is apparent.
In South Korea, Hong Kong, and Singa-
pore, productivity has grown rapidly, and so have wages. In Mexico, Argentina,
and Iran, productivity has fallen, and so have wages. The United States falls
about in the middle of the distribution: By international standards, U.S. pro-
ductivity growth and wage growth have been neither exceptionally bad nor ex-
ceptionally good.
What causes productivity and wages to vary so much over time and across
countries? A complete answer to this question requires an analysis of long-run
economic growth, a topic beyond the scope of this chapter. We can, however,
briefly note three key determinants of productivity:
◆
Physical capital:
When workers work with a larger quantity of equipment
and
structures, they produce more.
◆
Human capital:
When workers are more educated, they produce more.
◆
Technological knowledge:
When workers have access to more sophisticated
technologies, they produce more.
Physical capital, human capital, and technological knowledge are the ulti-
mate sources of most of the differences in productivity, wages, and standards of
living.
Ta b l e 1 8 - 2
P
RODUCTIVITY AND
W
AGE
G
ROWTH IN THE
U
NITED
S
TATES
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