Getting a “good” job is objectively harder nowadays. You could say some people were just “born at the right time,” like Americans who started their careers in the 1980s. And economists have some ideas about why that is when they look at the whole economy.
Welcome to the eighth week of Econ 101. Chapter 8 of the CORE Econ textbook “Economy, Society, and Public Policy” explores the relationship between inequality and unemployment.
Please note: There’s a lot of math involved in this week’s chapter, but you won’t find any of that in our key takeaways. We still recommend that you try solving some of the equations to fully grasp the concepts.
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Key takeaways
We learned in an earlier chapter that employers must pay wages well above the reservation wage if they want to motivate workers. We also learned that when employers pay these higher wages, there will be some people of working age who want a job but don’t have one.
Let’s look at an economic model known as the “wage-setting curve” to better understand how wages influence unemployment:
The wage-setting curve
At all points along the wage-setting curve, the purple line in the chart above, employers will pay workers the least amount needed to motivate them. But as the chart above shows, the point they select on the curve will make a big difference in unemployment.
The wage-setting curve will shift based on factors that increase or decrease workers’ cost of job loss, or employment rent — changes to unemployment benefits, more people in the labor force or more advanced workplace surveillance. The wage-setting curve can also move when employees join a trade union that negotiates working conditions and wages at higher levels than firms would prefer to pay.
Note that the y-axis of the chart is labeled “real wages,” which is different from what a worker is paid per hour. Real wages are wages adjusted for inflation, and they give economists a sense of what a worker can buy with what they earn.
For example, a worker making $15 an hour can buy more coffee if a cup costs $2.50 instead of $10. Real wages allow us to compare what workers earn in labor markets with what goods and services they can afford to buy.
As we learned last week, an employer also makes decisions about how much to pay workers based on the price that customers pay and whether that price maximizes profits. The best price for a good or service will depend on the firm’s input costs and the markup it can charge to consumers.
The price-setting curve
Employment will shift based on consumer demand, and the price-setting curve (really a straight line) will move up or down on the y-axis based on firm competition and worker productivity.
Remember, the y-axis is labeled “real wages,” which means the prices for goods and services are not expressed as the price customers pay, but as wages adjusted for inflation. That is why the price-setting curve moving downward doesn’t mean prices have gone down, but that a customer’s purchasing power has gone down. They can’t buy as much with the wages that they earn.
Put these two charts together, the price-setting curve and the wage-setting curve, and economists get an idea of what the macroeconomy looks like:
Equilibrium in the economy
👆 The X marks where the wage-setting curve and the price-setting curve intersect and represents an equilibrium at which:
- Workers are paid enough that they supply adequate effort.
- Firms employ workers at a level that matches the demand for the product workers produce.
- Firms set a profit-maximizing price for their goods and services.
- Unemployment, known as structural unemployment, will exist.
The firm is striking a balance: the product price must be high enough that the company makes a profit but low enough that people will still buy the product. The company then must also consider how that product price influences wages and whether workers will still be motivated to work hard and well.
(For more on this the “aggregate economy” model, watch this video tutorial from CORE Econ.)
When firms get larger and edge out competition, they typically can set higher markups and earn more profits.
Point A to point B: Less competition leads to a new equilibrium
That will shift the price-setting curve downward, resulting in a new equilibrium, from point A to point B, with lower real wages and higher unemployment.
That’s been the case for the last 40 years in the United States. The average markup that a U.S. firm charged in 2020 was more than double what it was in 1980. As a result, a greater percentage of market income has gone into the pockets of company owners rather than workers.
And real wages have fallen in the United States, as they did in our model, but unemployment has not gone up as one would expect. The number of workers stayed the same, possibly even grew.
When competition decreases, the price-setting curve shifts downward
What’s causing this? The textbook points to weaker trade unions as a possible explanation. Declining union membership could shift the wage-setting curve — as depicted by the dotted purple line in the chart above — to a new equilibrium at point C, where workers earned lower real wages without increasing unemployment.
Important definitions
- Unemployment rate: The proportion of the labor force who are not employed.
- Labor productivity: How many goods or services a worker produces in an hour (or some other measure of labor input).
- Real wages: Wages adjusted for inflation.
David Brancaccio’s thoughts on Chapter 8
Reading the chapter this week on who has the power to set wages, I was amused to see repeated references to shirking. The textbook says if a company does not pay enough for the labor of an employee, it can breed shirkers. The word sounds almost Elizabethan. To cut and paste into a line from William Shakespeare’s “Henry IV, Part 2”: “Away you scullion! You rampallian! You shirker!” (I inserted “shirker” in the spot where the Bard used “fustilarian.”)
A shirker is what 21st century people call a slacker. Economists believe if a company pays just the minimum, we will sleepwalk through our jobs and not give it our best. While instructive, this is a simplification. In my experience, what motivates us to do our best is a sense of purpose, the understanding that the work we do is meaningful, and that it adds up to something and helps make the world a better place.
More from Marketplace
Next week
In Chapter 9, we’ll dig into what credit markets are and how they can perpetuate inequality.
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This course was written and edited by Ellen Rolfes, Erica Phillips, Tony Wagner and David Brancaccio. It was originally published in February 2023 and updated in November 2024.
Revisit previous lessons:
- Chapter 1: The relationship between capitalism and income inequality
- Chapter 2: Game theory and rational decision making
- Chapter 3: How policymakers and economists assess fairness and efficiency
- Chapter 4: Finding balance between work and leisure (like an economist)
- Chapter 5: What is an “economic rent” and how does it influence working conditions?
- Chapter 6: Why companies often pay workers more than minimum wage
- Chapter 7: A primer on supply and demand, and how firms maximize profits