Economics of Discrimination: Economic Memo #55

As you know, I always try to start my memos with a funny story from my past. I am always amazed at the alumni I meet (now over 25,000 as I start my 50th year at Lewis) who repeat a “Hill Story” from one of my classes. I try to make the stories funny and relevant to a particular economic theory so the student remembers the concept.

This memo will be an exception. I have a story that is relevant but it’s not funny.

As a struggling college student in the early 1960’s, I worked summers in the steel mills in Gary, Indiana to earn the money I needed to go to school. My first two summers were in the billet mill, a particularly nasty work environment that was built in 1909. (I would go to work in a black sweatshirt and come home with a white shirt from all the salt I had sweated.) There was a fellow who knew more about the mill than anyone else. When a machine broke down they would call Earl Washington and he would immediately tell them how to fix it or fix it himself. Occasionally, a piece of white hot steel would get loose and he was called, even if it wasn’t his shift, to get the mill running again. He had a personality of a leader and the expertise of a champion. As a poor young white college student laborer (only white college students were hired in those days) Earl would see to it I got all the overtime and better paying laborer jobs ($2.38 per hour) that were available. I never forgot that.

For you see, Earl had been in the mill for nearly forty years and was only an assistant foreman. Because he was African-American he could not progress in management beyond assistant foreman.

I really didn’t understand the pain he must have overcome to help a white kid until I was called an “old white man.” The person who did that had no concept of what they had done. (Those of you who know my personality will recognize that after the conversation the person became well informed very quickly.)

The college days experience led me to cover the economics of discrimination in every class I teach. Given the recent comments of President Trump, which have broadly been criticized as emboldening the white supremacist concepts, it is worth exploring in a memo.

The hypothesis of the white supremacist is that discrimination is a good thing and only whites should be promoted. Implicit in that is the assertion it will create more American jobs and lower commodity prices. As an economist, I can’t find any theory where this concept would make me better off. Racism, sexism, and all the other ‘isms’ can’t be justified by any economic concept that I have learned and taught.

Let’s explore some of those concepts:

Supply and Demand
For those of you who don’t remember the demand curve slopes down and to the right (higher prices mean lower quantities demanded and vice versa) and the supply curve slopes upward and to the right (higher prices cause suppliers to want to supply more, and vice versa).

In theory and practice, if I discriminate and not let a person increase the productivity then my supply curve will shift to the left (at every price I will produce less) and the equilibrium price will increase and the quantity will decrease. It is clear they by discriminating, I lose.

Note that increasing productivity without discrimination will increase the supply curve and increase quantity and decrease price. Again, this argues against discrimination. Without discrimination, I get more goods at lower prices. I win!
Let’s explore the housing market reverting back to the 1960’s (Make American Great Again). People were forced to live in bounded areas due to discrimination. Banks would not loan to an African-American who wanted a home in white areas. (As my wife recently noted, let’s give some thought to “Making American Great Again”. That seems to imply that we go back to the 1950’s and things were all rosy in our memories. In truth, it wasn’t so rosy.)

So real estate investors would go to a block that bordered the African-American area and offer to purchase a home at a higher than market price. As soon as they owned it they would show the home to an African-American and then go to the rest of the block and offer rock bottom prices based on the fear that the area was racially turning. When all the homes on the block were purchased, the block busting real estate investor would offer the homes to African-Americans at a higher than average prices.

Everyone lost!

Production Possibilities Theory
If I can’t prove discrimination is better for me with supply and demand then maybe I could use the concept of production possibilities to prove it. (I continue to be amazed at the number of alumni that come up to me today that I had decades ago and they say, “I remember Guns and Butter” and can still carry on a conversation with the concept).

Anyway, remember that guns represents all government goods and machines, and butter represents all consumer goods. If we assume labor and several other factors of production are constant, then the law of increasing costs (in-order-to gain and extra unit of one good, you must give up more and more of the other good) applies. Thus, the production possibilities curve is bowed.

An increase in labor productivity will increase the PP curve since more Guns and Butter can be supplied with the same resources. I gain by allowing everyone to achieve their highest productivity. Just the opposite is true if I restrict a person’s productivity because of discrimination.

Returning Manufacturing to the United States: Profit Theory
Well, production possibilities didn’t work. Maybe profit theory will. Profit equals Total Revenue minus total cost, and Total Revenue is Price times quantity. Now let’s explore the price of Chinese bikes as an example.

Profit = Total Revenue minus Total Cost
Total Revenue = Price times Quantity

Let’s assume the Chinese can charge $100 a bike (really $80 for the lowest price in the US) and make a profit since their only costs are labor which is say $25, and the cost of transportation is $25. That means each bike they sell is at a profit of $50. The math of this is:
Profit ($50) = Total Revenue $100 (1 bike times $100) –  total cost ($50).

Let’s assume the US labor costs are 4 times the Chinese labor costs (That’s really close to the truth). The US company has little to no transportation costs. The only way for the US company to compete is to make more than 1.5 times as many bikes as the Chinese in the same time frame. Now the US bike manufacturer can meet the competitive $100 price and still make the same profit. The math is:
Profit ($50) = total revenue $150 (1.5 bikes times $100) – labor costs minus labor costs ($100).

An even better scenario is that the US productivity is 1.6 bikes. This would give the US a competitive advantage and the US consumer would pay less for the bike. We all win.
Profit ($58.40) = Total revenue $158.4 (1.6 bikes time $99) – $100

Let’s assume we discriminate and don’t allow women, African-Americans, Hispanics, and all the other groups that seem to be targeted to achieve their full potential productivity. It means all of us suffer by losing jobs and paying higher prices.

The assertion that only artificial protection through discrimination will ensure American jobs is actually counterproductive to creating American jobs and lower prices. IT’S FAKE NEWS!

I could go on with comparative and absolute advantage, progressive and regressive taxation, employment theory, etc. but you get the idea.

About Larry Hill

Dr. Larry Hill is Chair and Professor of Economics. Areas of interest include economic analysis, energy economics cost benefit analysis and economy. To subscribe to the email list of Dr. Larry Hill's Economic Memos, contact Tracey O'Brien at Credentials include 1967 B.S., Indiana State University, 1968 M.S., Indiana State University, 1976 Ph.D., Northern Illinois University He is a member of honorary fraternities in economics and social science. He is currently writing a book on Managerial Economics and revising previous book, "The Basic Macroeconomics of the American Economy"

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