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YOU DECIDE: What determines what you earn?

September 19, 2008

MEDIA CONTACT: Dr. Mike Walden, 919.515.4671 or michael_walden@ncsu.edu

Dr. Mike Walden
Media representatives: For a black-and-white or color copy of this photo, call 919.513.3127 or e-mail dave_caldwell@ncsu.edu.

Early in our marriage - now almost 30 years ago - my wife presented me with these questions.

"Explain to me," she said, "why professional baseball players, who engage in a sport that was invented for fun, earn a thousand times more than school teachers? Certainly teaching school is more important than hitting and throwing a baseball. How can our economy - or any economy - allow such a disparity to happen?"

My wife's questions are quite typical.

As we look around the economy and assign some level of importance to jobs, we see that pay and importance don't always seem to match. Jobs like school teachers, police, firefighters and nurses, all performing essential work that we can't do without, are paid substantially less than professional sports players, nationally renowned entertainers and actors, and executives of big companies. It makes many people, like my wife, wonder whether the job market is fair and logical.

Let me take a shot at explaining this, just as I have with my wife over 30 years (and, incidentally, she now almost agrees with me).

First, recognize we don't have a national economic dictator or governing board that sets what various jobs will be paid. Instead, we have a virtual economic free-for-all where workers and businesses are free to negotiate, accept and reject job offers and demands.

In this setting, the determination of salaries is rather simple.

Salaries will be set by the interaction of the demand for workers in a particular job and the supply of workers able to do that job. Jobs for which there is a high demand but a low supply will pay the most, jobs with a low demand and high supply will pay the least, and the pay of other jobs will be in the middle.

Let me drop the economics lingo and speak in intuitive terms. Businesses want to hire people who will make a lot of money for them; the more, the better. Therefore, workers who can pull in big bucks for a business will be more sought after (the demand for them will be higher) than workers who can only bring in small change. And the way for businesses to attract the big bucks workers is to offer them higher salaries.

But this is only half of the pay picture.

On the other side is how many big bucks workers there are. If they're everywhere (the supply is large), then even though each worker is very valuable to a company, companies won't have to work very hard to hire the workers, meaning salaries will be modest or low. In this case, the big supply trumps the big demand.

Yet if there are few of these valuable workers, then firms will be outbidding each other to grab them, so salaries will be high. So here the combination of big demand and small supply results in a gigantic paycheck for the workers.

Now let's go to the other end of the salary spectrum.

Jobs that contribute relatively little to the business's bottom line won't carry large pay offers. However, combine this with a situation where many people can do those jobs, and bingo! you get low demand combined with big supply, meaning a paycheck at the bottom end of the salary ladder.

So why do pro ballplayers get millions?

Because if they're good, they put a lot of people in the seats, sell a lot of merchandise for the team, and - perhaps most important in today's sports world - they jack up advertising rates. Plus, although many of us dreamed as kids of being ballplayers, very few folks can throw or hit a 90-mile-an-hour fastball, make a three-pointer with a hand in his face, or rush through a defensive line of 300-pounders. So big demand and low supply equals major league salaries for pro players.

And what about teachers?

Well, the reality is that more people can teach school than have the skills to play pro sports, so the supply of teachers is greater. In addition, schools, especially public schools, don't earn big revenues for teaching kids. The result, big supply plus modest demand, equals modest salaries.

It's alleged that when Babe Ruth was asked if he deserved a higher salary than the President of the United States, he responded, "Sure, I had a better year than he did." Who knew the Babe was an economist, because his statement succinctly describes how salaries are set.

Do something that many people place a high value on, be one of only a few who can do it and you'll be able to write your own ticket. But is this fair? You'll have to decide!

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Dr. Mike Walden is a William Neal Reynolds Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of N.C. State University's College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy. The Department of Communication Services provides his You Decide column every two weeks. Earlier You Decide columns are at http://www.cals.ncsu.edu/agcomm/writing/walden/decide.htm

Related audio files are at http://www.ncsu.edu/waldenradio/

Posted by Dave at September 19, 2008 08:44 AM