Households derive their incomes from three basic sources: from wages or salaries received in exchange for labor; from property, like land, capital, and so forth; and from government.
Wages and Salaries
About 60 percent of personal income in the United States in 2000 was received in the form of wages and salaries. As we saw in an earlier chapter, competitive market theory predicts that all factors of production are paid a return equal to their marginal revenue product (the market value of what they produce at the margin). There are reasons why some types of labor may be more productive than others and why some households have higher incomes than others.
Required Skills, Human Capital, and Working Conditions
One explanation for differing wages and salaries is that people have different marginal revenue products based on their skills, education, talents, and background. The rewards of a skill that is in limited supply depend on the demand for that skill. (For example, the salaries of male professional basketball players far exceed those of women players in the sport, but that is not true in tennis.)
Not all skills are inborn; some people have invested in training and schooling to improve their knowledge and skills (what we call investing in human capital) and therein lies another source of inequality in wages.
Sometimes, the salary for less desirable jobs also reflects a compensation for the unpleasant aspects of the job. For instance, many consulting firms pay a higher salary if they place an employee at an overseas office. Very desirable jobs often have low salaries for the exact opposite reason.
Multiple Household Incomes
Households also have different wages and salaries because some households have more wage earners than other households do. Roughly 60% of the women that are over 16 in the U.S. were employed in the year 2000 and many married couples live on two incomes. As the number of single-income households changes, it could be expected that the distribution of wages and income will change.
This explanation for differing wages also highlights a problem with using income distribution as a measure for equity. Many households have a great deal of non-wage earning activity that provides utility, but looking at the income distribution does not capture that utility. Two families may be identical in every respect, except that in one family, a parent stays home and cares for the children, while in the other family, both parents work and a portion of their income is used to pay for child care. Both families may be equally happy, but if income distribution is used as a measure for equity, it looks as though one family is better off than the other.
The Minimum Wage Controversy
Many countries have used the minimum wage as a strategy for reducing wage inequity. In recent years this has come under attack; opponents argue that minimum wage legislation interferes with the smooth function of the labor market and creates unemployment. Proponents argue that it has been successful in raising the wages of the poorest workers and alleviating poverty without creating much unemployment.
To read about the minimum wage, consult the current events articles on the companion web site.
When the economy goes through an economic downturn, people are unable to find jobs. For some workers, the cost of unemployment is reduced by unemployment compensation benefits paid out of a fund accumulated with receipts from a tax on payrolls.
For understanding of how wages might vary with the demand for labor in the profession, try the following EGraph exercises: