Question

Consider an economy of only two industries, one high wage and the other low wage. Each employs the same number of workers, equally divided between two occupational groups: skilled and unskilled. Skilled workers are identical with each other in the two industries, and so are the unskilled.

• The low-wage industry pays its skilled labour $10 an hour and its unskilled labour $5, during both a recession and an expansion; that is, it has a rigid wage structure.

• The high-wage industry pays its skilled labour $20 per hour in both a recession and an expansion, but it pays its unskilled workers $5 during recession and $15 during expansion; that is, only its skilled wages are rigid over the business cycle. Assume that there is a barrier to mobility between the two industries, preventing worker migration between the two industries.

a) For the whole economy, calculate the inter-occupational wage differential (ratio of skilled to unskilled wages) in both the recession and the expansion.

b) Calculate the inter-industry wage differential (ratio of high- to low-wage industries) for both skilled and unskilled workers in both the recession and the expansion.

c) Why does the inter-occupational wage differential narrow in the expansion and widen in the interindustry?

Answer 1

a. The inter-occupational wage differential: skilled wages/unskilled wages
In recession= (10+20)/(5+5)= 3
In expansion= (10+20)/(5+15)= 1.5
b. The inter-industry wage differential: high wage/low wage industry
In recession:
Skilled workers= 20/10=2
Unskilled workers= 5/5=1
In expansion:
Skilled workers= 20/10=2
Unskilled workers= 15/5=3

c. The unskilled workers are usually not paid as per their ability or are underpaid, so in the times of expansion, by paying more the industries build on their credibility so that when there would be cut in wages in recession, the workers chose to stay with the industry and cause not to deepen the recession any further.