Why do people get paid different amounts? The easy answer is that your boss is a jerk. But we saw that in a competitive labor market, wages equal the marginal revenue product of labor. Workers whose product is worth more are paid more.
If you have a rare skill that people value, maybe you can dunk from the free throw line and play elite level defense, maybe you're a brilliant lawyer, maybe you're a fantastic actor, then you'll get paid more for your job. You produce more value as judged by the market. People sometimes complain about the pay of say, professional basketball players compared to a more, let's be fair, necessary profession like nursing. It's true that we could live without the NBA, though I'm not sure I'd want to live without the San Antonio Spurs. But let's think about why pro basketball players are paid so much more.
It's absolutely true that the total value of nursing is much higher than the total value of basketball. But the marginal value of a great basketball player is incredibly high. And remember that wages equal the marginal revenue product of labor. the amount of value produced by the next worker.
The supply of people who can play basketball at the pro level is pretty low, whereas the supply of people who could be nurses is much higher. Consumers value the entertainment provided by pro basketball, so signing a great player yields a very high marginal revenue product of labor. Hiring another nurse produces value too, of course, but it's a relatively small amount of marginal value.
And you should start to be able to see why salaries in certain professions including pro sports, finance, and technology have gone up by so much in recent years. Technological advances mean that many, many more people can be reached by the very best in their profession. In the 1980s and even 1990s, the market for NBA jerseys and the whole NBA product was limited to pretty much the United States. But today, pro basketball is wildly popular around the world thanks to satellite TV and streaming services.
A top player reaches a far greater number of people than he might have 30 years ago. Even though he plays the same number of games, the value of his output is much greater because there's much greater demand for it. His marginal revenue product of labor is higher, so his wages are higher. Wages are set by the market.
Why does a cook in a developing country like India get paid so much less than a cook in the United States? They may both work just as hard, but the American cook is more productive because American kitchens have a lot more equipment. And the output of the American cook is more valuable because willingness and ability to pay for a restaurant meal in the United States is much higher than in India. The American cook's value marginal product of labor is much higher. The American cook gets the benefit of productivity in other sectors of the American economy, because options in other sectors are good, wages in the restaurant industry are higher.
The outside opportunities for an American cook are more lucrative. They could work in another industry, so pay in the restaurant industry can't be too different than in other sectors. Now notice that your wages aren't entirely determined by your own skills, but also the productivity of the entire economy.
Now supply plays a role in all this too, of course. There are lots of workers in India who would view working in a restaurant kitchen as a very attractive job relative to the number of workers in the United States who would want to do that. So the supply of potential cooks is relatively higher in India, pushing wages down. Now let's delve deeper into why people might be paid different amounts.
One straightforward explanation is that of human capital. That's the stock of skills that each person has that helps determine their productivity. Education, on-the-job training, and experience can boost human capital, which in turn makes you a more productive worker. More productive means higher marginal revenue product of labor, and therefore higher wages.
Another explanation centers around aspects of the jobs themselves. Higher risk or very unpleasant work has to compensate people for those unattractive features, or else they'll do something else. Imagine that a job fishing volatile hazardous chemicals out of the toilets of a maximum security prison paid the same amount as cleaning the bathrooms at a five-star resort. No one would take the prison toilet job, so they would have to raise their wages in order to attract workers. Similarly, Neither fast food cooks nor garbage collectors require very much training or skill.
Yet garbage collectors are paid almost twice as much on average as fast food cooks. Why? It's a less pleasant job and workers in that industry have to be compensated for those unpleasant factors. These are called compensating wage differentials. or sometimes just compensating differentials.
These are differences in wages that offset differences in working conditions. Riskier jobs and less pleasant jobs have to pay more than similar jobs that don't have those aspects. Driving a truck as a contractor in a war zone pays much more than driving a truck long haul across the country, which in turn pays more than driving a truck around town for deliveries. Compensating differentials for the same job driving a truck. It can even come down to how much of a jerk your boss can be.
If they're really terrible, then wages have to be higher than they might otherwise be at a similar firm or else no one would work for the jerk boss. So you should think about that in a couple years when you're fielding awesome job offers. Why is this firm offering a higher salary than that one?
Are working conditions less pleasant? Is it in a city with a higher cost of living? Are the benefits not as good?
The final potential reason why people's wages might differ discrimination. That's a big topic so we'll tackle it in the next video.