A2 Markets & Market Systems

Wage Determination in Competitive Markets

Wage Determination in Competitive Markets
Explanations for wage differentials in the labour market

There is a very wide gulf in pay and earnings rates between different occupations in the UK labour market. No one factor explains the gulf in pay that exists and persists between occupations and within each sector of the economy. Some of the relevant factors are listed below

Compensating wage differentials - higher pay can often be some reward for risk-taking in certain jobs, working in poor conditions and having to work unsocial hours
Equalising difference and human capital - wage differentials compensate workers for (opportunity and direct) costs of human capital acquisition. There is an opportunity cost in acquiring qualifications - measured by the current earnings foregone by staying in full or part-time education.
Different skill levels - the gap between poorly skilled and highly skilled workers gets wider each year. One reason is that the demand for skilled labour grows more quickly than the demand for semi-skilled workers. This pushes up average pay levels.
Differences in labour productivity and revenue creation - workers whose efficiency is highest and ability to generate revenue for a firm should be rewarded with higher pay. Top sports stars can command top wages because of their potential to generate extra revenue from ticket sales and merchandising
Trade unions - unions might exercise their collective bargaining power to achieve a mark-up on wages compared to those of to non-union members
Employer discrimination is a factor that cannot be ignored

Earnings in the Labour Market

Weekly Pay - Gross (£) - For all employee jobs: UK, 2005

	Number
	of jobs			Percentiles
	(thousand)	Median	Mean	10	90
Health professionals	241	920.0	1,036.4	285.7	1,982.5
Corporate managers	2,943	636.9	774.5	312.5	1,348.3
Business and public service professionals	624	589.1	669.2	307.4	1,076.7
All employees	23,606	349.6	423.2	104.6	766.6
Skilled trades occupations	1,903	390.4	412.5	208.4	637.9
Administrative and secretarial occupations	3,323	278.8	291.3	120.0	464.4
Customer service occupations	340	236.4	231.6	80.8	366.3
Caring personal service occupations	1,527	204.4	215.4	78.3	355.6
Sales and customer service occupations	1,902	160.1	182.7	55.7	329.3
Source: 2005 Annual Survey of Hours and Earnings

Sticky wages in the labour market

Economists often refer to the existence of “sticky wages” in many labour markets. In a fully flexible labour market, a decrease in the demand for labour should cause a fall in the wage level and a fall in employment - just like any demand curve shifting down. (See the diagram below).

However, sticky wages refers to a situation in which the real wage level doesn't fall immediately, partly because most employees have wages specified in medium-term employment contracts that cannot be renegotiated immediately, and partly because workers (perhaps protected by their trade unions) are resistant to cuts in nominal wages. If the wage level cannot fall when demand falls, it leads to a much bigger drop in employment and, more importantly, involuntary unemployment because of a failure of the labour market to clear.

The empirical evidence for sticky wages is a good counter-argument to neo-classical models of the labour market that suggest that real wage levels respond flexibly to any changes in labour demand and supply conditions

Sticky wages in the labour market

Author: Geoff Riley, Eton College, September 2006

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A2 Markets & Market Systems

Wage Determination in Competitive Markets

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