Chapter 6. Discrimination, Exploitation, Productivity and Labor Issues

PART II. BUSINESS ECONOMICS

Questions for consideration:

What is “labor”? What is the typical role of labor in various production processes? How do firms choose whether to hire workers or buy machines to do the work? Why do workers earn so little compared to managers?

In the next few chapters we move to a sub-discipline known as “business economics”. In this area we are largely concerned with how firms and markets are organized for business and how business decisions are made. Most firms are in business to make a profit. We make a simplifying assumption in economics that firms attempt to maximize their profits subject to resource constraints and the cost of marketing those products. Profit (per unit of time) is calculated as revenue minus cost. So a firm that desires to maximize profits must either increase its revenues or decrease its costs. We will examine cost structures in the next chapter and revenue options for firms immediately following the cost chapter. However, as we shall see, an analysis of cost structures is necessarily also an analysis of productivity, since the two items are intricately related. Hence the theoretical focus in this chapter will be on productivity.

Labor Issues

Production is never accomplished without the use of labor as an input. Even the most automated, mechanized factory setting requires employees to program the computers and push the buttons. This has been true since the beginning of time. Although a number of edible plants grow wild (tubers, nuts and berries, tropical fruits), most land is unproductive until someone tills the soil and plants the seed. Labor-intensive production methods still dominate in many lesser- developed countries, and many families are completely financially dependent on wage income. There are a whole host of labor issues worthy of exploration. In addition to those mentioned in the title, other items include labor unions, minimum wage, gender issues, and globalization impacts on labor. We will need some additional economic tools in order to adequately explore these issues, so we first present an analysis of productivity before discussing these labor issues.

Production and Productivity

We begin with a few definitions. Productivity and costs are inversely related. For two workers who are paid at the same wage rate, the employee who is more productive generates output at lower per-unit costs than the one who is less productive. Productivity is measured as output per unit of input, while costs are measured as inputs (in monetary value terms) per unit of output. The output of a firm is its production of goods and services. The inputs are the factors of production – land, labor, capital and entrepreneurial activity. We classify inputs as either fixed or variable. Variable inputs are those inputs that change with production, such as raw materials, energy use, and labor. For our purposes, we will have labor as our only variable input. Fixed inputs are those inputs that are unchanging, that do not vary as we increase or decrease production levels. Land, buildings, and capital equipment are typically regarded as fixed inputs. Output can be quoted at one of three levels: total, average, and marginal. Total output is straightforward – the amount of production by a firm or a factory in a specific period of time. When output is calculated at the last two levels, the concept is more appropriately referred to as productivity – output per unit of input. Average output, more appropriately known as average product, is the amount of total output divided by the amount of labor input. We calculate average output on a daily basis in a number of areas. Sports examples are abundant. In soccer we speak of minutes per game for individual players, goals allowed by the keeper per shots attempted, and goals per game for the team. Player statistics are kept in basketball for points, rebounds and assists per game and in baseball for batting average, fielding percentage, and earned run average. National statistics are also calculated as averages. We calculate GDP per capita, doctors per 1000 citizens, and electricity use per household. All these “average” calculations are measures of productivity.

Marginal product, on the other hand, is the amount of output generated by one more unit of labor input. That is, if we add one more worker to the production process, how much additional output is produced. Marginal calculations are less common, but examples abound. Income taxes have average and marginal calculations. The amount of income tax paid divided by the amount of income earned is the average tax rate. But the amount of additional income tax that would be paid if a person earned an additional €1000 is a marginal calculation. When we say that farm land is marginal for production, we mean that the land will barely yield enough produce to justify tilling the soil and planting the seed. A college student has an “overall” grade point average (GPA) for all the time s/he has been in college, but also a grade point average calculation for each term. The former of these is an average calculation, the GPA calculated over all terms. The latter is a marginal calculation, the GPA for only the last term.

A numeric example will help to clarify these terms. Suppose we have a factory that produces hand-crafted clocks. There are fixed inputs in place – the land, the building, and the machinery. Each clock produced will use the same amount of raw materials (wood, internal workings and paint) and the same amount of energy. Even though the energy and raw materials are variable, they fall into a separate classification of variables that are exactly proportional to output. We will say more about these proportional inputs later. As noted above, labor will be our only truly variable input. In the following equation the quantity of output is specified as a function of the labor input:

(1) Q = X * L2 - Y * L3 , where Q is the number of clocks produced per month and L is the number of workers employed. X and Y are parameters that are estimated from data gathered from hundreds of clock factories, with industrial engineers and economists working together to try to understand the relationship between the number of workers employed in a typical clock factory and the output generated. Equation (1) is known as a production function in one variable. Output is specified as a function of the one variable input, labor. Suppose we apply values to the estimated parameters, with X equal to 28 and Y equal to 2, so the equation becomes Q = 28 * L2 - 2 * L3 . Although these parameter values are fabricated for this example, in reality they might have been obtained through data gathering and estimation, as noted above. For labor input from zero to ten employees, the equation generates Table 6.1 and the accompanying charts in Figure 6.1. When zero labor is employed the total output of clocks produced, shown in the second column, is necessarily zero. The first worker then generates 26 clocks ( = 28*12 - 2*13). Adding a second worker results in 96 clocks (= 28*22 - 2*23). The total output for three workers is 198 clocks (= 28*32 - 2*33), and so on, with the output for ten workers equal to 800 (= 28*102 - 2*103). The average product and marginal product are calculated in the last two columns. Average product is calculated as total output (Q) divided by the amount of labor input (L). So the average product for one worker is 26 (= 26 / 1); for two workers the average product is 48 (= 96 / 2), and so on. Marginal product is calculated as the change in output divided by the change in the number of workers. When the change in the number of workers is one, then marginal product is the difference in output for two consecutive workers. So the marginal product for the first worker is 26 (= 26 - 0). The marginal product for the second worker is 70, equal to the output of 96 for two workers minus the output of 26 for one worker. That is, the second worker contributes an additional 70 clocks to the firm’s total output. As we go down the list, we can calculate the marginal product for any worker, if we know the output for the previous worker. Thus the marginal product for the eighth worker is 82 clocks, equal to 768 clocks produced by eight workers minus the 686 clocks produced by seven workers.

The marginal product calculations probably seem strange to someone new to economics. The first worker adds 26 clocks to the total output, while the second worker has a marginal contribution nearly three times greater, 70 clocks. Can the second worker be that much more productive? The answer is no, especially if we assume that these craftsmen have roughly equal abilities. The reason the second worker is so much more productive is because of specialization and the division of labor. One worker by him/herself must do every chore necessary to build a clock. When two people work together, however, they can split up the work more efficiently, each doing more of what s/he enjoys or more tasks that require his/her particular skill areas. Adding a third worker and then additional workers beyond that simply reinforces the efficiency gains the second worker added. In fact, the marginal product calculations continue to increase up through the fifth worker added to the factory.

After the fifth worker, the marginal product of each additional worker decreases, due to the law of (eventually) diminishing returns. This “law” states that as variable inputs (only increases in labor in this case) are added to fixed inputs, output will first increase because inputs are being combined efficiently, but eventually additional inputs lead to smaller, even negative increases in output. The marginal product calculations above rise with the first five employees, then begin to fall with the sixth (from130 to 126) when diminishing returns sets in. Marginal product decreases with additional workers, but continues to remain positive until the tenth worker is Table 6.1

Labor Product Average Marginal Input Output Product Product L Q AP MP 0 0 1 26 26 26 2 96 48 70 3 198 66 102 4 320 80 122 5 450 90 130 6 576 96 126 7 686 98 110 8 768 96 82 9 810 90 42 10 800 80 -10 added. At that point congestion has set in. There are too many workers or too few tools in the factory to warrant the addition of a tenth worker – s/he gets in the way more than s/he contributes.

Consider planting 100 hectares of land using only hand tools. One person alone could never fully utilize the land. But as more workers are added specializations develop. One person plows, another plants, another waters, another fertilizes, another cultivates. Adding more workers leads to more specializations, but smaller increases in output. Eventually too many workers in the field begin to get in each other’s way, even trampling the output, and the marginal product turns negative. It has been said that if we did not have diminishing returns, one worker and one potted plant could produce the entire world food supply.

The graphs to the right of the table are plots of the average product (AP) and marginal product (MP) columns. Both sets of data are upside-down “U” shapes. They first rise to a maximum, then begin to decrease, with the marginal product graph rising and falling more sharply than the average product graph. The interesting point is that the marginal product intersects the average product at the average product’s maximum value. This intersection is important and helps to illustrate the marginal-average relationship: When the marginal is above the average it pulls the average up, and when the marginal is below the average it pulls the average down. Take note in particular at the sixth and seventh workers. Although the marginal product is falling as these workers are added, the marginal product is still above the average product, and the average product rises at each point compared to its previous level. The previous marginal product examples help to clarify this marginal-average relationship. Any college student knows that his/her grades each term will affect his/her overall GPA. If this term’s GPA is higher than the overall GPA, the overall GPA will rise. If it is lower, the GPA will fall. And if a soccer game results in a shutout for the home team, the keeper’s “goals per shots attempted” average will fall. The Market for Resources

All of the costs incurred by business can be attributed to payments made to the factors of production. That is (recalling the Circular Flow diagram in Chapter 2), all the inputs used in the production process can be classified as land, including raw materials, land for production agriculture, and land as investment property; labor, both salaried and hourly; and capital, both financial and physical (plant, equipment and machinery). One of the more significant costs affecting business worldwide is the cost of labor. In many countries machinery is rare or the cost of energy required to run the machines is prohibitive. In addition, many countries have an abundant supply of labor and relatively low wage rates, making the use of labor more attractive than the use of alternative inputs. Thus in looking at input markets, we will focus on the market for labor.

The Demand for Labor

The demand for labor is a "derived demand", derived from the demand for the product. Workers are hired because they are needed for the production of goods and services, which are then sold in product markets, generating profits for business entrepreneurs, managers and investors. If there is no demand for the product, there is no labor needed to produce the product. Conversely, the more the product is in demand, the more labor will be demanded to produce the product. That is, the demand for labor will reflect the firm’s willingness and ability to hire workers. The supply of labor will reflect individuals’ willingness and abilities to work in specific employment opportunities. Wages and employment will then be determined by the intersection of the demand for labor and the supply of labor.

The firm’s demand for labor follows from the productivity analysis we undertook above. The output (Q) and marginal product (MP) data from Table 6.1 are reproduced in Table 6.2 below, with three additional columns added to reflect the revenue associated with the sale of the clocks. We assume that the firm can sell all the clocks they produce at a constant selling price of €25, as shown in the first additional column. The revenue generated by the sale of the clocks, equal to the amount of output (Q) multiplied by the selling price, is shown in the second new column. The third new column is a new concept, marginal revenue product (MRP). The marginal revenue product for labor is the increase in revenue generated by one additional worker. This concept stands in contrast to marginal product, which is the amount of physical output generated by one more worker. Henceforth we will use the term marginal physical product (MPP) instead of marginal product to refer to the marginal output increase. The marginal revenue product is calculated at the change in total revenue divided by the change in labor input. In Table 6.2, the change in labor input is one, so the MRP is simply the change in total revenue from one line of the table to the next. MRP can also be calculated as the marginal physical product (MPP) multiplied by the selling price. For consecutive input levels, the two calculations give identical results. The plot of the MRP calculations from Table 6.2 is provided in Figure 6.2. The graph is identical to the graph of marginal product in Figure 6.1, except that the vertical axis is changed. Now we consider the decision a manager must make if s/he is concerned with how many workers to hire. Suppose the wage rate for a craftsman skilled in handcrafted clocks is €3000 per month.

Table 6.2

Marginal Selling Total L Q MP Revenue Price Revenue Product 0 0 €25 0 n.a. 1 26 26 €25 €650 €650 2 96 70 €25 €2,400 €1,750 3 198 102 €25 €4,950 €2,550 4 320 122 €25 €8 ,000 €3,050 5 450 130 €25 €11,250 €3,250 6 576 126 €25 €14,400 €3,150 7 686 110 €25 €17,150 €2,750 8 768 82 €25 €19,200 €2,050 9 810 42 €25 €20,250 €1,050 10 800 -10 €25

How many employees should the manager hire? First, we know the manager should hire on the down side of the MRP function since diminishing marginal returns have not yet set in. Second, the manager clearly does not want to hire the tenth worker, since that worker’s marginal physical product is negative. So the choice comes down to hiring between six and nine employees. The employment decision comes down to a comparison between the cost of a new hire and the benefit that new worker brings. Hiring the sixth worker costs €3000 and brings in €3150 additional revenue to the firm. So the sixth worker should be hired. Hiring the seventh worker also costs €3000, but that worker only brings in €2750 additional revenue. Hiring the seventh employee would result in a cost outlay greater than the revenue generated, so the seventh employee should not be hired. Thus the employment level in this example would be six workers.

Now, suppose the wage rate were to rise to €3200. At that point the cost of the sixth worker would exceed the benefit derived from that worker (€3150), and the sixth worker would not be hired. That is, an increase in the wage rate results in a decrease in the quantity of labor hired. But suppose the wage rate were to fall, say to €2700. At that wage rate, hiring the seventh worker makes economic sense, in that the marginal revenue product (€2750) exceeds the wage rate. Thus a decrease in the wage rate results in an increase in the quantity of labor hired. The decisions we have just made are the same types of decisions consumers face when making a purchase decision, except that here the purchase decision is in the hands of the plant manager. But what we see from this analysis is that the marginal revenue product curve is the demand for labor, in that it is consistent with the law of demand and answers the question of how much will be purchased (in this case, labor) at alternative prices (in this case, wages). As with the demand for products that we studied in Chapter 2, the demand for labor is not static; it also shifts with changes in the market. There are four major labor demand shifters. The first is the price of the product that the labor produces. The demand for labor shifts to the right with increases in the price of the product and shifts to the left with decreases in the product price. This outcome follows from the calculation of the marginal revenue product. When the product price increases each of the MRP calculations increase, since the MRP is calculated as the MPP multiplied by the product price. The vertical shift that results from those MRP increases is also a shift to the right horizontally, hence an increase in the demand for labor. The demand for labor also shifts to the right (increases) with enhancements in technology and with increases in labor productivity. Each of these changes results in an increase in the marginal physical product, resulting also in increases in the marginal revenue product and increases in the demand for labor. Finally, the demand for labor shifts to the right with increased prices of other inputs, especially increases in the price of machinery or energy costs. Machinery and equipment are substitutes for labor and, as with the product substitutes that we studied in Chapter 2, an increase in the price of a substitute good leads to an increase in the demand for the good in question.

The Supply of Labor and Labor Market Equilibrium

Firms demand labor and individuals supply labor. The supply of labor for an individual begins with the individual’s reservation wage, which is the minimum wage an individual must receive before s/he is willing to work. Naturally each individual can have a number of reservation wages, each one different for different work opportunities. For most college students their reservation wages for working at Tesco would be much lower than their reservation wages for sifting through garbage in the local recycling center. But if we look at a normal job that is not too tedious or too dirty or too dangerous, the supply of labor for an individual has a positive vertical intercept (the reservation wage), is then mostly horizontal over a normal work week, and is then positively sloped as the number of hours worked per week is greater and greater. That is, an individual is willing to work more and more hours per week as the wage rate increases. In many factory settings people regularly volunteer for overtime hours and weekend or holiday duty. The market supply of labor is the horizontal summation of the willingness of all individual workers to supply labor, as shown in Figure 6.3. The market supply of labor is upward sloping, indicating that more people are willing to work at higher wage rates. At even higher wage rates, the supply of labor may be "backward bending", indicating that wages are so high that some workers reduce their hours worked or actually leave the labor force, preferring leisure time at home over the additional income. As with the demand for labor, the supply of labor shifts over time. The leading labor supply shifter is an increase in population, due to increased immigration or a higher population growth rate. The supply of labor also changes for different industries, depending on job attractiveness and worker preferences. That is, as more attractive opportunities become available, people are less inclined to offer their services for the less attractive positions. Many janitorial and manual labor positions in industrialized countries are filled with immigrants, since most of the native citizens are relatively well off and are less willing to work at these less attractive positions. Income earned from investments and rental activities can also reduce the amount of hours worked, again with people preferring their leisure time over work.

The equilibrium wage rate is determined by the intersection of the labor demand and labor supply curves. This is shown in Figure 6.3 at €5.3 per hour, with 14,000 workers employed. But as we learned in Chapter 2, equilibrium is not nearly so interesting as disequilibrium, so we now turn our attention to a number of disequilibrium situations.

Minimum Wage

A minimum wage is a legally enforced price floor. Workers can be paid more than the wage that is set by law, but they cannot be paid less. Figure 6.4 shows a minimum wage of €6 imposed on the labor supply and demand conditions from Figure 6.3. When the minimum wage is effective, that is, when the minimum wage is greater than the market equilibrium wage, three outcomes occur. First, unless the demand for labor is perfectly inelastic, firms will move along their market demand curve, reducing the number of workers they wish to hire. In Figure 6.4 the quantity demanded is reduced from 14,000 to 11,000 workers. Second, more workers are now willing to work. In the diagram, then number of available workers increases from 14,000 to 20,000. The increase in the quantity supplied together with the decrease in the quantity demanded results in an excess supply of workers at the €6 wage rate. Finally, from a societal welfare standpoint, there will be a deadweight loss, equal to the triangular wedge between the demand and supply curves, from the demand-supply intersection to the new quantity of labor demanded by the firms.

The intent of minimum wage legislation is to raise the welfare of the working class, but there is no guarantee that workers as a whole benefit. Consider Figures 6.5 and 6.6. In both diagrams the supply curve is unit elastic throughout, the market equilibrium wage rate is €5.3 with 26,000 workers employed at that wage rate, and the minimum wage is €6 with 30,000 workers willing and able to work at that wage rate. The difference between the two diagrams lies with the demand curves. The demand curve in Figure 6.5 is drawn fairly inelastic while the demand curve in 6.6 is elastic. When the minimum wage is enacted, firms reduce their hiring by 2000 workers in Figure 6.5 and by 8000 workers in Figure 6.6. The 2000 workers in Figure 6.5 lose their hourly wage of €5.3, a total of €10,600 per hour, while the 24,000 remaining workers gain €0.7 per hour, a total of €17,500 per hour. Thus the gain for the remaining workers is greater than the loss to those who lost their jobs. The numbers for Figure 6.5 are quite different. The 18,000 who retain their jobs increase their total hourly wage by €12,600, while the 8000 who lost their jobs give up €42,400 per hour, a staggering loss of almost €30,000 per hour. The conclusion for the above analysis is that workers as a whole benefit if they are in jobs with an inelastic demand for labor, but lose if they are in jobs that have an elastic demand for labor. The demand for labor will (in general) be inelastic if there are no good substitutes for labor, and will be elastic if substitutes are available. Naturally, the major substitute for labor is capital equipment and machinery. In country after country we have seen automated garbage trucks replace workers, a substitution of capital for labor – clearly an elastic demand. But there are other jobs that machines cannot do. Hotel housekeeping is one such job. There is no machine that can change the linens, vacuum the floors, or clean the bathrooms. Hotel managers try to reduce the labor time required wherever possible, but replacing the workers is impossible. By contrast, fast food restaurants have become very capital intensive. Machines have replaced people in many of the day-to-day chores. Cooking is very automated – a package of frozen french fries is placed in a metal basket, a button is pushed, the basket is lowered into a cooker, and the cooked fries pop up a few minutes later. Soda delivery is also automated – a worker places a cup under a dispenser spout, pushes the button, and comes back a short time later to cap the soda and take it to the customer.

So the minimum wage is not a straightforward proposition. An attempt to benefit workers through higher wages could backfire and actually do harm instead. Workers as a whole will benefit only if the demand for labor is substantially inelastic. In addition the firms lose, through higher labor costs or through machinery purchase costs to replace the higher-cost labor. Finally, society loses the deadweight triangle (as noted above), and that loss increases as the demand for labor is more elastic (compare the deadweight loss in Figure 6.5 with that in Figure 6.6).

Exploitation

A second disequilibrium labor situation is worker exploitation, a setting in which workers are substantially underpaid for the work they do. Exploitation typically occurs in situations where the employer has substantial market power and is able to enforce low wages or poor working conditions. This occurs most often when there is only one major employer in a village or region, as in a mining town or a rural factory setting. We will cover exploitation only briefly here, in that we need a bit more economic understanding of market power before we can tackle it more fully.

A graphical depiction of exploitation is shown in Figure 6.7. In a normal competitive market, the equilibrium wage rate would be €6 per hour, with 2400 workers hired. However, when there is only one employer who is able to exert market power over the town’s labor force, that employer hires only 1600 workers and pays a wage rate of €4 per hour. But the value of the workers when 1600 are hired (their marginal revenue product) is €8 per hour. That is, the employer is able to profit handsomely by paying the 1600 workers only €4 per hour when their value is €8 per hour. As we shall see later, the employer is looking for the biggest rectangle of profit, where the profit is calculated as the quantity of labor hired multiplied by the gap between the demand curve and the supply curve at that quantity of labor. Obviously, the gap is greatest at the vertical axis, but with no workers hired there is no profit. At the other extreme, there is no gap between the supply and the demand curves at the market equilibrium wage, so again profit would be zero. The largest rectangle of profit, therefore, will be somewhere between zero workers and the quantity of labor hired at the market equilibrium wage rate. We will be more specific as to that amount of labor hired when we study market power in Chapter 9.

We typically think of exploitation occurring in lesser developed countries or in underdeveloped areas in industrial countries. In both of these situations there tends to be a large pool of workers available who have few other job opportunities available. Thus employers are able to hire workers without concern for competition from other firms who want to hire the same workers. Those workers who are hired receive a wage rate that is lower than the market equilibrium rate, plus they must often suffer through longer working hours and poor working conditions. However, many workers in these situations are often so thankful just to have a job that they do not complain about the low wages, the long hours, or the bad working conditions. After all, there are 8000 other workers standing by ready and willing to take their jobs!

Labor Unions

Reactions by workers to employer exploitation have ranged from passive acceptance of wages and working conditions to violent opposition. A middle-ground response has been the creation of labor unions, organizations of workers banding together to present a more unified front as a reaction to harsh or unfair treatment by management. Although medieval craft guilds were the historical ancestors of today’s modern labor unions, organized opposition to employer abuse did not become widespread until the Industrial Revolution. Low wages, the use of child labor, and generally poor working conditions in Europe and the United States led to early organized attempts to do battle with management, but were met with much resistance from employers who often had the weight of government on their side. Only in the early 1900s did labor unions finally begin to gain more widespread acceptance and to begin to have influence on public policy.

Labor unions attempt to close the exploitation gap in Figure 6.7 through concerted action by its members. Ideally unions try to encourage (or enforce) an “all or nothing” approach to the supply of labor. That is, whereas management tries to limit the number of workers hired to 16,000 and to keep the wage rate low at €4 (Figure 6.7), unions attempt to create a perfectly inelastic labor supply curve at 24,000 workers, thereby forcing the wage rate to increase to €6. Unions have been largely successful in reducing employer exploitation, and have continued to work through collective action to improve wages and working conditions. Sometimes this results in a union organizing in an otherwise competitive market and attempting to establish a wage rate higher than the market wage would otherwise be. This disequilibrium wage results in layoffs and increased unemployment, but those who remain on the job realize increased wages and benefits. As with the minimum wage discussion above, this activity results in winners and losers, and it is often the case that the aggregate wage gain to those who keep their job is less than the amount of income lost to those who are no longer employed. Hence union leaders must strike a balance between increased wage levels for those with seniority (longer time on the job) and a higher employment level to benefit newer labor force entrants.

Labor union history is long, varied and rich, but a fair telling of its tale is far too much for this text. Readers are encouraged to explore the labor union movement on their own. Those in Central and Eastern Europe would be particularly interested in the Solidarity labor party in Poland, led by Lech Walesa. One of the more dramatic labor union movements in history, the Solidarity Party was largely responsible for the demise of Communist influence in Poland and Eastern Europe, to the ending of Soviet control in Eastern Europe in 1989, and ultimately to the breakup of the Soviet Union in 1991.

Discrimination

Discrimination in the workplace occurs when one group of workers, on the basis of physical or social characteristics, receives either preferential treatment (positive discrimination) or unfavorable treatment (negative discrimination) from managers, customers, or co-workers. Discrimination is most often defined with respect to gender, race, age, religion, or national origin. Lately discrimination based on sexual orientation has been added to the list of prohibitions in a number of more advanced countries. Likewise, physical disabilities can also be a basis for a discrimination claim. Discrimination is most commonly referred to in the negative, as when a female feels that she has been discriminated against in consideration for a promotion.

Allegations of discrimination by management are often heard in the context of hiring and promotion decisions, work assignments, and termination of employment. One person feels that she was not hired because she was female, another feels that he was denied promotion because he is Muslim, a third feels that he gets assigned the dirty tasks because he is of Roma descent, and a fourth wonders if her outspoken homosexuality led to her unexpected termination. In direct contrast, many white males feel the burden of reverse discrimination, the favorable treatment of women and minorities that results in hiring and promotion decisions adversely affecting white males. Co-workers can also engage in discriminatory activities. It is not uncommon for people with similar interests and backgrounds to congregate together. But it can become hurtful when commonality becomes exclusion, when one group of workers actively dissociates from or creates a hostile work environment for another group or individual. Finally, customers can also contribute to workplace discrimination, as when a young bride-to-be wants only a female wedding coordinator or when a farmer refuses the offer of consultation with a female agricultural engineer. Naturally, some customer preferences are justified, as when a female who has been sexually molested wants to be seen only by a female psychologist or corrections officer.

Figure 6.8 shows the economic effects of discrimination. The market equilibrium in Figure 6.7 had 24,000 workers hired at a wage rate of €6 per hour. With employer discrimination 16,000 of those workers receive favorable treatment (DF) at a wage rate of €7 per hour, while 8000 workers receive discriminatory treatment (DD) at a wage rate of only €4 per hour, forty-three percent lower than the favored group. The wage bill remains the same for the employer, €144,000 per hour, but the favored group has a seventy-five percent built-in incentive program to remain on the job while the ill-treated group has every motivation to look for better opportunities elsewhere. Workplace discrimination is sometimes confused with occupational choice differences. In Figure 6.9 there are two groups of teachers, those with mathematical skills (SM) who teach science and math and those with verbal skills (SV) who teach languages and writing. The demand for both groups of teachers is similar – schools need teachers with both sets of skills – but the supply of those mathematically inclined is much less than the supply of those with verbal skills. Hence, those with mathematical skills are able to obtain higher salaries. Most of the differences in salaries or wage rates are not the result of discrimination. Someone claiming occupational discrimination is often forced to defend his/her claim by showing that the alleged activity is in fact discriminatory and not the result of other factors. Education and experience are two of the most important factors explaining wage differences. Educational level is important, but the school(s) attended and how well a person did in school are also important. Experience also is not just the number of years on the job, but the quality and performance record of the work in those positions. Licenses and certificates also enhance a person’s ability to obtain higher salaried positions. Special abilities are important in explaining wage differences. A service employee who is able to converse in two or three languages is clearly more useful to a firm than someone who knows only his/her native tongue. The cost of living also leads to wage differentials for people doing essentially the same work. Typically cities have higher living costs than rural areas, and a wage premium is paid to accommodate that increased cost of living. Finally, the attractiveness of the job affects wage levels. The more attractive the job, the more persons will be applying for the position, and the lower will be the salary. Safe jobs typically pay less than dangerous jobs. Hard work pays more than easy work. Fun jobs get a number of applications and pay less than boring positions. And getting dirty on the job will often get a worker a higher wage than a clean, pristine position. Finally, the more flexible the hours, the less the pay compared to a more rigid work schedule.

Discrimination is an action; prejudice is the feeling behind that action. Discrimination is often aimed at an entire group with one individual serving as the target for the group. In order to eliminate discrimination by managers and co-workers, it is often necessary to eliminate the prejudice that exists prior to the discriminatory behavior. Although many countries have equal opportunity and affirmative action laws, in the final analysis the elimination of discrimination requires that individual attitudes change. Education and interaction are the key ingredients to encouraging these attitude adjustments. In February 2005 a number of Central European countries announced the beginning of a “Decade of Roma Inclusion”. Bulgaria, Croatia, the Czech Republic, Hungary, FYR Macedonia, Romania, Serbia and Montenegro, and Slovakia are the founding countries of the Decade. According to the Open Society Institute, “...the Decade will monitor progress in ending the severe discrimination and crippling poverty faced by Romani communities in the region. Each country will set a limited number of measurable national goals for improvements in four priority areas: education, employment, health, and housing. The Decade will monitor progress in accelerating social inclusion and improving the economic and social status of Roma across the region.” (http://www.soros.org/initiatives/roma)

Land and Capital Markets

The focus in this chapter has been primarily on labor markets. Similar productivity and market analyses could also be undertaken for the other two factors of production, land and capital. The market for agricultural land is relatively straightforward. A great deal of land is better suited to agricultural production than to any other use. However, different regions of the country have different productivity levels, and even within a particular region some tracts of land are more productive than others. The more productive is the land, the higher will be its marginal revenue product, and the greater will be its selling price when it is put up for sale (ceteris paribus). The raw materials in the land – the oil, minerals and precious metals – are also straightforward market analyses. While these natural resources are perfectly inelastic in supply (they are non- renewable resources), their extraction is an increasing cost operation, and the supply of raw materials is a positively sloped function.

In a sense, the market for capital is also similar to the market for labor. Those who supply financial capital are paid a market rate of interest, determined by the interaction of their savings supply and the demand for investment capital by firms and individuals. However, the demand for investment capital is not so straightforward. In the aggregate the market demand for investment capital is downward sloping – financial capital is used to purchase equipment and machinery. Marginal productivity analysis can be undertaken on these potential purchases to determine the highest valued piece of equipment or machinery, and firms then make the decision as to how much machinery to buy. However, the final purchase decision on a major piece of equipment is a much more complex decision, in need of further analysis.

Suppose a firm is considering purchasing a major piece of equipment. We assume that the firm will be reinvesting some of its past profits rather than borrowing the money in capital markets, so as to eliminate the added complexity of the cost of borrowing. The equipment will cost the firm €100,000, but would generate an additional €10,000 in profit each year. The equipment will deteriorate slightly each year, but it would be expected that maintenance and repair could keep it running productively for fifteen years. The question is, should the firm purchase the equipment? At first glance, the answer is a resounding YES!! An additional €10,000 profit each year for fifteen years comes to a €150,000 increase in profits compared to the purchase price of €100,000, or a net profit of €50,000. But there are two problems with this simple analysis.

The first problem is the opportunity cost of the original €100,000 investment. Suppose that the €100,000 could have been invested in a bond paying six percent return per year. The €6000 return per year over a fifteen year horizon would have resulted in €90,000, clearly a superior investment compared to the capital equipment’s return of €50,000. The second problem concerns the time value of money. The expenditure on the investment would be made in the current time period while the returns on the investment would occur in future time periods, and future cash is not worth as much as current cash. To understand this statement, consider whether you would rather have €100 today or a promise of €100 one year from now. Most rational people would choose the cash today. At the least, they could put the €100 in the bank and have an extra €2 or €3 in one year’s time. The future value of money in one year (FV) can be calculated from the present value (PV) using the following equation: FV = PV + PV * r , or

FV = PV * (1+ r) , where “r” is the annual market rate of interest expressed in hundredths (e.g., 0.08). If we wish to calculate the future value two years out, the equation changes only slightly:

FV = [ PV * (1+ r) ] * (1+r) , or

FV = PV * (1+ r)2 .

Continuing with this pattern, we can calculate the future value N years from now (with a fixed rate of return) using the following equation:

FV = PV * (1+ r)N .

If we rearrange this equation and solve for PV we get:

PV = FV / (1+ r)N .

That is, the present value of future money is discounted back into the current time period by dividing the future value N years from now by a denominator that grows exponentially. If we use a discount rate of eight percent, the €10,000 return is worth only €9259 in present value terms at the end of the first year, €8573 at the end of the second year, €7938 at the end of the third year, and so on. At the end of fifteen years, the present value of that stream of €10,000 returns is worth only €85,595, an amount far less than the €100,000 purchase price. Using a smaller discount rate of six percent results in a smaller denominator and a larger present value, but the 15-year stream of returns still comes to only €97,122. Naturally lower discount rates would result in positive returns, but the choice of discount rate is typically related to the cost of borrowing, and the cost of commercial borrowing has not been below five percent since the 1950s. Thus we see that the equipment purchase is a bad deal, due to both the opportunity cost considerations and the present value calculations.