An Economic Question

[PokerProdigy]

Often in labor disputes, both unions and management try to gain public support by pointing fingers at one another. Management may claim that the wage demands by its production workers are excessive and will lead to higher prices for its products, hurting consumers. The union may counter by claiming that if the company were really concerned with the public paying higher prices they would not pay their top executives the enourmous salaries they recieve.

Now the questions.

1) Is the management claim that increasing workers salaries will result in higher prices (for consumers) true? And why or why not?

2) Is the union claim that increasing executive salaries will result in higher prices (for consumers) true? And why or why not?

[BluffTHIS!]

Obviously any higher fixed or variable costs are going to be passed on as price increases, if the competitive market situation allows it. Plus, there is a reason Chinese produced garments are so cheap. Regarding the comparative impact of increasing worker wages versus executive salaries, you would have to see specific numbers for a specific company to see which actually produces the greater aggregate expense. Nonetheless, it seems true that executive compensation in America is excessive compared to Japanese compensation where a typical CEO might not be paid more than 100x the average worker wage, although that doesn't take into account perks such as company provided golf club memberships that might be worth hundreds of thousands. It is also interesting to note that typically liberally biased media when reporting about union wage disagreements often do not give the average union wage which is being contested over, and which if given in the story, would often be so high compared to the average Joe making $12 an hour, that most average Joes would have little sympathy for union workers making $20-$30 an hour not counting beneifits, while contending that those wages need to be increased still further. Union labor's prime axiom is that labor costs should not be used as a competitive advantage, which is why management often responds by avoiding such disagreements and farming out production to Asian and Mexican factories.

[disjunction]

I always wondered about this, because it seems like a common fallacy. Theoretically, a company should charge whatever they can get by the laws of supply and demand. But if you listen to sports talk radio, for example, they'll state that ticket prices are high because player salaries are high. So if the players were getting paid pennies, what, the ballclubs would lower ticket prices and give their profits away to the fans? Yeah, right.

And yet when you get away from theory, there's something to be said for necessity of costs driving the pricing. People and companies are naturally drawn to inaction, so maybe the ballclubs would have taken longer to think of raising their prices if they didn't "need" to. And also the amount needed to offset costs seems to be a kind of psychological inflection point, kind of the same mentality that makes people more reluctant to call a raise at the higher limits because of the money involved.

[drudman]

Neither should be true because the distribution of wages is independant of the market value of the product being manufactured... right?

[[censored]]

the balance between the supply of product and the demand of the product determines the price of product.

The cost simply determines if the entrepreneur makes the product at all.

labor both worker and executive is product. see above for how prices to products are determined.

[goofball]

[ QUOTE ]
the balance between the supply of product and the demand of the product determines the price of product.

The cost simply determines if the entrepreneur makes the product at all.

labor both worker and executive is product. see above for how prices to products are determined.

[/ QUOTE ]

Perfect.

[Darryl_P]

The answer to both is not necessarily. Both of those statements are propaganda for the unsophisticated public. The reality is that compensation levels are determined by a host of strategic considerations (mainly related to the current market) as are the prices of the products. There is some overlap in the factors affecting the two but it's not that great (about 20% I'd say). So in some situations one may lead to the other, while in others it wouldn't.

[Piers]

[ QUOTE ]
1) Is the management claim that increasing workers salaries will result in higher prices (for consumers) true? And why or why not?

[/ QUOTE ]

It depends.

If salaries are too low, moral loss will likely cause a greater loss than the money gained from reduced salaries. Also salaries lower than competing companies in the same sector will make recruiting suitable employees more difficult.

However if salaries are too high, then the some of the cost is not counter balanced by increased moral and ease of recruitment. Hence the company will loose competitiveness compared with other companies in the same industry.

[ QUOTE ]
2) Is the union claim that increasing executive salaries will result in higher prices (for consumers) true? And why or why not?

[/ QUOTE ]

It depends on whether the executive is worth the salary.

A very good top executive might gain a company tens of millions compared with a less able executive. Paying him millions in salary just makes good financial sense.

[PokerProdigy]

I learned in my micro-economics class that the production employees salary increase would actually increase the price that the company charges the consumer. Yet, if the executives salary is increased it does NOT effect the price the company charges the consumer.

Now, does anybody know why?

[PokerProdigy]

[ QUOTE ]
I always wondered about this, because it seems like a common fallacy. Theoretically, a company should charge whatever they can get by the laws of supply and demand. But if you listen to sports talk radio, for example, they'll state that ticket prices are high because player salaries are high. So if the players were getting paid pennies, what, the ballclubs would lower ticket prices and give their profits away to the fans? Yeah, right.

And yet when you get away from theory, there's something to be said for necessity of costs driving the pricing. People and companies are naturally drawn to inaction, so maybe the ballclubs would have taken longer to think of raising their prices if they didn't "need" to. And also the amount needed to offset costs seems to be a kind of psychological inflection point, kind of the same mentality that makes people more reluctant to call a raise at the higher limits because of the money involved.

[/ QUOTE ]

You're right. When the owner of a sports franchise says that the ticket prices have risen because of the enourmous salaries of athletes, he's sorta lying. Actually, the reason ticket prices have risen is because he is trying to make the most amount of money he can (which he should) by selling his product. The only way that the athletes may have made ticket prices higher is that they are so good, that the demand for their product is so high, that the owner is correct (in terms of trying to maximize profits, which is the goal of all profit seeking businesses) to charge higher prices. If the owner paid the athletes less, than maybe they wouldn't do the work or maybe they wouldn't perform as well, but as far as the owner saying that basically he has to "make up" for the player salaries by charging more for tickets, this is just a line of BS. What he should be saying is that "I am raising ticket prices, because I am trying to squeeze every penny of profit I can out of this business, and in this case the way to do that is to raise ticket prices." But most people would dislike the owner for saying this so instead he blames the athletes to save face (which is a lie) and the consumers don't have a problem with him. Also, I want to make sure that you guys realize that I don't have a problem with him charging more, because I realize he is just trying to maximize his profits by raising ticket prices. Just like I don't have a problem with pro athletes sighing huge contracts because they obviously deserve it, in the sense that they get that money, and since the market determines prices they must deserve that money, atleast in an economic sense.

[BadBoyBenny]

If employee labor is factored into costing models then an increase in labor will lead to a higher cost of goods sold on the income statement. To maintain operating margins, the company will increase prices accordingly.

Executive compensation is part of overhead, and affects net margins, but not operating margins. In the long term this will affect profitability and thus pricing, however it does not tie directly into a materials + labor accounting model.

Also, for many executives a large portion of their compensation comes in bonuses that are given based on the previous year's experience. These are usually tied to profitability, so this compensation is given after the product is sold and the profit from the margins are realized.


However, I think this concept is somewhat dated anymore as most companies have more sophisticated cost accounting models that would recognize the increased overhead from higher executive salaries in their prices.

[PokerProdigy]

[ QUOTE ]
If employee labor is factored into costing models then an increase in labor will lead to a higher cost of goods sold on the income statement. To maintain operating margins, the company will increase prices accordingly.

Executive compensation is part of overhead, and affects net margins, but not operating margins. In the long term this will affect profitability and thus pricing, however it does not tie directly into a materials + labor accounting model.

Also, for many executives a large portion of their compensation comes in bonuses that are given based on the previous year's experience. These are usually tied to profitability, so this compensation is given after the product is sold and the profit from the margins are realized.


However, I think this concept is somewhat dated anymore as most companies have more sophisticated cost accounting models that would recognize the increased overhead from higher executive salaries in their prices.

[/ QUOTE ]

I didn't understand everything you said, but you definitely hit the nail on the head when you mentioned that executives salaries is all part of overhead which does not effect cost of products. Furthermore, employee's salaries is a marginal cost and marginal costs do effect cost of products.

One thing that I disagree with though, was that you mentioned that the companies have really complicated cost accounting models, because honestly this doesn't matter. Basically, they are always charging the price that makes them the most money, which is tied into the demand for their product. However, when they raise a CEO's salary then that price would still be the same, in other words, the price that allows that company to make the most money has NOT changed. However, when they raise the employees salary then they usually raise the price, but NOT to "make up for the money spent" like most people think, but rather because the price that the company should charge which will make them the most money has changed. It all ties into the idea of overhead costs vs. marginal costs, and profit is always maximized when marginal costs = marginal benefits.

MAN I LOVE ECONOMICS /images/graemlins/grin.gif