Chapter 9

Labor Market
Discrimination
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
Labor Economics, 4
th
edition
10 - 2
Introduction
Discrimination occurs when the marketplace takes into account
such factors as race and sex when making economic exchanges.
As a result, the costs and benefits of the exchange depends on
these factors.
10 - 3
Race and Gender in the Labor Market
Men earn more than women and whites earn more than
nonwhites.
Partly because of labor supply differentials among groups.
- E.g. more white men work full time.
Differences in educational attainment between whites and
nonwhites would clearly generate wage differentials
- E.g. whites have higher education than blacks on average.
10 - 4
The Discrimination Coefficient
Taste discrimination an economic concept that essentially translates the
notion of racial prejudice
- Even though it costs wb dollars to hire one person-hour of black
labor, because of taste against blacks, the employer will act as if it
costs wb(1+d) dollars, where d is positive and called the
discrimination coefficient
- Racial prejudice causes employers to blindly perceive the costs of hiring
blacks as higher than their true costs.


10 - 5
Even though it costs wb dollars to hire one person-hour of black
labor, because of taste for blacks, the employer may act as if it costs
wb(1-n) dollars, where n is positive and called the nepotism
coefficient
- Nepotism causes employers to blindly perceive the costs of hiring
blacks as lower than their true costs.

10 - 6
Source of discrimination
Employer
Employee
Customer


Discrimination Coefficient: independent of the source.
10 - 7
Employer Discrimination
If black and white workers are perfect substitutes:
- q=f(Ew+Eb)
Ew: number of white employees
Eb: number of black employees

Since the two types are identical in production, firm should hire
the cheaper type.
- If Wb<Ww whom to hire?
10 - 8
Employer Discrimination
If black and white workers are perfect substitutes:
- q=f(Ew+Eb)
Ew: number of white employees
Eb: number of black employees

Since the two types are identical in production, firm should hire
the cheaper type.
- If Wb<Ww hire black only
10 - 9
The Employment Decision of a Firm
That Does Not Discriminate
VMP
E

w
B

E
B

Employment
Dollars
If the market-determined
black wage is less than the
white wage, a firm that does
not discriminate will hire
only blacks. It hires black
workers up to the point
where the black wage
equals the value of marginal
product of labor, or E*
B
.
10 - 10
Employer Discrimination
In a discriminatory firm, the firm acts as if black wage is
Wb(1+d)
- Hire only blacks if Wb(1+d)<Ww
- Hire only whites if Wb(1+d)>Ww
If blacks and whites are perfect substitutes, employers have a
segregated work force (an implication of the Becker model)
- Firms differ in the d: degree of prejudice
- For all d, s.t. Wb(1+d)>Ww white firms
- For all d, s.t. Wb(1+d)<Ww black firms


10 - 11
The Employment Decision of a
Prejudiced Firm
VMP
E

E
W

w
W

Employment
Employment
Dollars
VMP
E

E
B

w
B
(1+d
1
)
w
B
(1+d
0
)
w
B

*
1

Dollars
(a) White Firm
(b) Black Firm
Firms that discriminate can be either white firms (if the discrimination coefficient is very
high) or black firms (if the discrimination coefficient is relatively low). A white firm hires
white workers up to the point where the white wage equals the value of marginal product.
A black firm hires black workers up to the point where the utility-adjusted black wage
equals the value of marginal product. Firms that discriminate hire fewer workers than
firms that do not discriminate. WHY?
10 - 12
Discrimination and Profit
Discrimination does not pay: Employers hire the wrong color
worker and/or they hire the wrong number of workers
- White firms hire the wrong type of workers: black workers
are cheaper;
- White firms also hire too few workers
- Black firms hire the right type of workers, but too few,
unless their decimation coefficient is zero.
10 - 13
Profits and Discrimination
Dollars
Discrimination
Coefficient
d
W

0
t
MAX
t
W

White
Firms
Black
Firms
Discrimination reduces
profits in two ways. Even
if the discriminatory firm
hires only black workers,
it hires too few workers.
If the discriminatory firm
hires only white workers,
it hires too few workers at
a very high wage. ( beyond
dw, only hire white workers.
Number of employees, and
hence profit no longer change
with d)
10 - 14
Determination of Black/White Wage
Ratio in the Labor Market
How does the demand for black workers change with the
black/white wage ratio?
This implies the demand curve should be ? sloping?
10 - 15
Determination of Black/White Wage
Ratio in the Labor Market
Black-White
Wage Ratio
Black
Employment
(w
B
/w
W
)
*

N 0
1
R
D
S
D'
(w
B
/w
W
)'
If the black-white wage ratio is very high,
no firm in the labor market will want to
hire blacks. As the black-white wage ratio
falls, more and more firms are
compensated for their disutility and the
demand for black workers rises.
(downward sloping demand curve) The
equilibrium black-white wage ratio is
given by the intersection of supply and
demand, and equals (wB/wW)*. If some
firms prefer to hire blacks, they would be
willing to hire blacks even if the black-
white wage ratio exceeds 1, shifting the
demand curve up to D'. If the supply of
blacks is sufficiently small, it is then
possible for the black-white wage ratio to
exceed 1.
10 - 16
The Black-White Wage Ratio in the
Labor Market
If all employers discriminate against blacks a wage gap
between equally skilled black and white workers. Black-white
wage ratio<1.
Non random allocation: Black workers are hired by firms that
have least prejudice, white workers are matched with employers
who dislike blacks the most.
If some employers prefer to hire blacks (nepotism) demand
curve for blacks shifts up; if black labor supply is small, black-
white wage ratio could exceeds 1 even if most firms dislike
blacks.
10 - 17
Employee Discrimination
White workers act as if their wage is Ww(1-d) in a firm with
black workers; but act normally (see wage as Ww) in a firm
with only white workers.
- For a firm with black workers to attract white workers, it has to
pay more than Ww.
Firms are color-blind: blacks and whites are the same
- If Ww<Wb hire only whites
- If Ww>Wb hire only blacks
Will a firm hire both blacks and whites?


10 - 18
Employee discrimination


A firm will never hire both.
- If Ww<Wb hire only whites
- If Ww>Wb hire only blacks
- if Ww=Wb, still hire only one type, since if hire both, whites will
demand more than Ww


10 - 19
Employee discrimination
Employee discrimination does not generate a wage differential
between equally skilled black and white workers
WHY?
10 - 20
Employee discrimination
Employee discrimination does not generate a wage differential
between equally skilled black and white workers
- If Ww>Wb demand for whites goes down Ww goes down
- If Wb>Ww demand for blacks goes down Wb goes down
- Until Wb=Ww blacks and whites with same quality earn the
same wage , but hired in different firms.
Employee discrimination does not affect firms profit. Because
white workers and black workers are equally productive and
equally costly. There is no advantage/disadvantage for being a
white/black firm.

10 - 21
Customer Discrimination
If customers discriminate, their perceived price of a good is
utility-adjusted with the discrimination coefficient, acts as if
price is p(1+d).
If a firm can hide black workers (avoid their contact with
customers) no adverse impact on black wages
- If Wb<Ww, demand for black workers in hidden positions goes
up Wb goes up.
When a firm cannot hide black workers, customer
discrimination can have an adverse impact on black wages
- Firm has to lower price in order to compensate customers for
disutility black worker has to compensate the firm for the loss
in profit.
10 - 22
Statistical Discrimination
This form of discrimination is based on treating an individual
on the basis of membership in a group and knowledge of that
groups history.
Because firms cannot perfectly predict the risks or rewards
from particular economic transactions (e.g. productivity of a
potential employee is not perfectly known), they will use
statistics about the average performance of the group this
person belongs to, to predict his productivity Market
outcome for a particular individual would be affected by the
average performance of people similar to him/her.
10 - 23
The Impact of Statistical Discrimination on
Wages
Use T as a comprehensive score, summarizing all the
information of an individual applicant.
Statistical discrimination applicants expected productivity
depends both on her own T and the average score of her group.

] 1 , 0 [ : : ) 1 (
) 1 (
e
+ =
o o o
o o
slope Intercept T
T T w
10 - 24
The Impact of Statistical Discrimination on
Wages
.



Higher alpha own test score T is better predictor of
individual productivity.
If T<Tbar, you would prefer ?
If T>Tbar, you would prefer?

] 1 , 0 [ : : ) 1 (
) 1 (
e
+ =
o o o
o o
slope Intercept T
T T w
10 - 25
The Impact of Statistical Discrimination on
Wages



Workers with T<Tbar get paid more than their own ability
guarantees.
Workers with T>Tbar get paid less than their own ability
guarantees.


] 1 , 0 [ : : ) 1 (
) 1 (
e
+ =
o o o
o o
slope Intercept T
T T w
10 - 26
The Impact of Statistical Discrimination
on Wages
Dollars
White
Black
Test Score T
*

T

Dollars
Test Score
(a) Whites have higher average score
(b) Test is better predictor for white
workers
The workers wage depends not only on his own test score, but also on the mean test
score of workers in his racial group. (a) If black workers, on average, score lower
than white workers, a white worker who gets T* points earns more than a black
worker with the same score. (b) If the test is a better predictor of productivity for
white workers, high-scoring whites earn more than high-scoring blacks, and low-
scoring whites earn less than low-scoring blacks.
10 - 27
Measuring Discrimination
One possible definition of discrimination is given as the
difference in mean wages: not proper if quality differs across
groups need to control for this.
The better measure would compare the wages of equally skilled
workers
Oaxaca decomposition a technique that decomposes the raw
wage differential into a portion related to different skills and a
portion related attributable to labor marker discrimination
10 - 28
Oaxaca decomposition
) ( ] ) ( ) [(
) (
F M
M
F
F M F M
F
F F
M
M M
F M
F F F F
M M M M
s s s w
s s w w w
s w
s w
+ + = A
+ + = = A
+ =
+ =
| | | o o
| o | o
| o
| o
Earnings function from regression model.
The term in [] is differential due to discrimination: even if they have the
same quality, men and women are paid differently
The second term is wage differential due to difference in skills: average men
have high quality than average women.
10 - 29
Measuring the Impact of Gender
Discrimination on the Wage
Dollars
Mens Earnings
Function
Womens Earnings
Function
Schooling
s

F
s

M

w

M

w
F

o
M

w

F

o
F

The average woman has sF years of
schooling and earns w

F dollars. The
average man has sM years of schooling and
earns w

M dollars. Part of the wage
differential arises because men have more
schooling than women. If the average
woman was paid as if she were a man, she
would earn wF dollars.
A measure of discrimination is then given
by (wFw

F).
*
F
w
*
F
w
10 - 30
Policy Application: Determinants of the
Male-Female Wage Ratio
Occupational crowding has segregated women into
particular occupations where the return to education is
lower.

Human capital is more profitable the longer the payoff
period.

Women are better off if they enter occupations in
which their skills do not deteriorate during the years
they spend in the household sector.
10 - 31
Trend in the Female-Male
Earnings Ratio, 1960-2005
0.5
0.55
0.6
0.65
0.7
0.75
0.8
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Year
F
e
m
a
l
e
-
m
a
l
e

e
a
r
n
i
n
g
s

r
a
t
i
o
10 - 32
Male-female wage ratio declined rapidly during 1980s and
1990s.
- Most importantly: increase in female labor market experience.
More attached to labor market. This would lead to?
- Decline in the extent to which men and women are treated
differently in the market: the gap in rate of return to skills
between men and women narrowed.
- Some government program (e.g. affirmative action, comparable
worth) may also have some effect.
10 - 33
Policy Application: Determinants of the
White-Black Wage Ratio
There has been an upward trend in the wages of blacks in recent
years
This has been attributed to increases in the quality and quantity
of black schooling (quality component in Oaxaca)
- Blacks years of schooling increases.
- School quality difference decreases difference in the rates of
return to school decreases
Government programs have positively affected black wages
- Civil Rights Act: prohibits employment discrimination based on
race and sex. (discrimination component in Oaxaca)
10 - 34
Trend in Black-White Earnings Ratio,
1967-2005
Sources: U.S. Bureau of the Census, Historical Income TablesPeople, Tables P-38A and P-38B. Full-
Time Year-Round Black and White Workers by Median Earnings and Sex:
http://landview.census.gov/hhes/income/histinc/incperdet.html. The earnings refer to the median earnings
of full-time, full-year workers aged 15 or above.
10 - 35
Male Labor Force Participation Rates,
by Race, 1955-2005

60
65
70
75
80
85
90
1950 1960 1970 1980 1990 2000 2010
Year
P
a
r
t
i
c
i
p
a
t
i
o
n

r
a
t
e
Bl ack
Whi te
10 - 36
Another explanation
If the least skilled black workers drop out of labor force, the
average skill among black workers (in the labor force) would
increase the average wage for black workers would increase.
10 - 37
The Decline in the Labor Force Participation
of Blacks and the Average Black Wage
Frequency
Wage rate
w
~
1
w
~
2
w

1
w

2

10 - 38
The Decline in the Labor Force Participation
of Blacks and the Average Black Wage
Suppose blacks originally have reservation wage w
~
1 ,
those
whose wage rate is higher than w
~
1
works: the average wage
rate for working blacks is: w

1


Suppose blacks reservation wage increases to w
~
2 ,
those
whose wage rate is higher than w
~
2
works: the average wage
rate for working blacks is: w

2.


10 - 39
Discrimination Against Other Groups
Differences in wages can be linked to varying educational
attainment
Less skilled workers earn less, just as human capital theory
proposes
Asians tend to have an advantage over white workers, mainly
due to schooling
10 - 40
Trend in Earnings Ratio of Hispanics
and Asians, 1974-2005
Sources: U.S. Bureau of the Census, Historical Income TablesPeople, Tables P-38C and P-38D. Full-Time
Year-Round Asian and Hispanic Workers by Median Earnings and Sex:
http://landview.census.gov/hhes/income/histinc/incperdet.html. The earnings refer to the median earnings of full-
time, full-year workers aged 15 or above. The denominator in the ratios gives the earnings of white men or
women, respectively.
10 - 41
Example
Each employer faces competitive weekly wages of $2,000 for
whites and $1,400 for blacks. Suppose employers under-
value the efforts/skills of blacks in the production process.
In particular, every firm is associated with a discrimination
coefficient, d where 0 d 1. In particular, although a
firms actual production function is Q = 10(E
W
+ E
B
), the
firm manager acts as if its production function is Q = 10E
W

+ 10(1 d)E
B
. Every firm sells its output at a constant price
of $240 per unit up to a weekly total of 150 units of output.
No firm can sell more than 150 units of output without
reducing its price to $0.

10 - 42
(a) What is the value of the marginal product of each white
worker?


(b) What is the value of the marginal product of each black
worker?



10 - 43
a) The value of marginal product of each white worker is
$2,400, because each white worker produces 10 units of output,
and each unit of output (up to 150 units) can be sold for $240.

b) The value of marginal product of each black worker is
$2,400, because each black worker produces 10 units of output,
and each unit of output (up to 150 units) can be sold for $240.
Notice that discriminatory beliefs on the part of the firm owner
do not affect a black workers true marginal product.



10 - 44
(c) For what value(s) of d is a firm willing to hire blacks?
whites?



10 - 45
Each white worker produces $400 of profit for the firm. Each
black worker, while costing $1,400 is perceived to produce
$2,400(1 d) of revenue. Thus, each black worker is perceived
as producing $2,400(1 d) $1,400 = $1,000 $2,400d of
profit. The firm is willing to hire black workers, therefore, if
1,000 2,400d 400
600 2,400d
0.25 d.

Thus, the firm hires blacks as long as d is at most 0.25. For
d>0.25, only whites; for d<0.25 only blacks; for d=0.25
indifferent.

10 - 46
End of Chapter 9