wage differentials

Question 1

Wage differentials

Answer 1

If labour markets are very competitive, with identical workers and perfect mobility of labour, wages will move towards the same equilibrium level. However, in reality wages can differ greatly, even for the same job. A variety of different factors account for this, including the following.

Question 2

Human capital differences

Answer 2

Some jobs require lengthy training and education, and this is reflected in higher wages. Human capital is the quantity and quality of labour and human capital development is the process of improving the quality of labour through education and training.

Human capital development, through education and training, is a considerable cost to individuals and firms, both in terms of time spent and resources used. Firms are aware that they must compensate for human capital development to attract the necessary skilled labour they require. Airlines, for example, know that they must pay skilled pilots significantly more than semi-skilled cabin crew to compensate pilots for the greater sacrifice pilots make during their lengthy education and training. In contrast, airlines only need to pay a relatively low wage to unskilled cleaners because there is little education or training needed, and therefore, little human capital development.

Over time, market forces will adjust the cost and benefit of education and training so that labour shortages in one area push up the wage rate, and it becomes more worthwhile to train for jobs in these shortage areas.

Question 3

Formal education

Answer 3

Formal education is an important determinant of human capital, and wages. Lifetime earnings vary directly with education and an individual who just obtains ‘A’ Levels, will earn much less, on average, than an individual with a university degree.

Question 4

Wages and skills

Answer 4

The demand for skilled workers is greater than the demand for unskilled workers because the value of the output produced by skilled workers will be higher, and can command a higher price.
The marginal cost of acquiring a skill and improving human capital is greater, so the skilled worker’s supply curve is to the left of the unskilled worker. The combined effect of the higher demand and lower supply is that wages for skilled workers are often much higher that for unskilled workers.
Because of the greater human capital required, skilled workers expect a higher wage to encourage them to supply more labour.

Question 5

In the UK, the gap between the earnings of skilled and unskilled workers has risen in recent years, mainly for two reasons:

Answer 5

1. Technological change and the new economy have increased the productivity of many skilled workers. The application of IT is often more possible in skilled occupations compared with unskilled ones.
2. International trade and globalisation have had a significant downward impact on the pay of the unskilled. In contrast, the skilled, especially those in the service sector, are generally less adversely effected by global competition. The recent financial crisis has meant that the financial services sector has experienced difficulties in terms of pay, but the skills gap and resultant pay gap is unlikely to narrow in any significant way.

Question 6

The national minimum wage

Answer 6

The government can also influence the wage rate by setting a national minimum wage.
The effect is that demand contracts from Q to Q1 and supply extends from Q to Q2 creating a surplus of labour.