CompDiffs_6

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Compensating Differentials Read pages: 239-246 Adam Smith • Adam Smith, Wealth of Nations , 1776 “The wages of labour vary with the ease or hardship, the cleanliness or dirtiness, the honorableness or dishonorableness of the employment.” Job Selection Question of interest: How do workers choose which industry, occupation or firm to join? Industries, occupations and firms differ in their work environment, risk of injury and employee benefits, safety, job security, etc. We will assume that workers have preferences over these job characteristics, though different workers may have different preferences. Compensating Differentials Example: Suppose two manufacturing firms want to hire ten low-skilled workers each to work in their factories. Firm 1’s factory is maintained to be clean and safe, while firm 2’s factory is dirty and noisy. There are 20 workers available to work in manufacturing and both firms offer these workers a wage of \$10/hour. At \$10/hour, all of the workers want to work for firm 1. There is an excess supply of workers to firm 1 and an excess demand for workers for firm 2. So a wage of \$10/hour for both firms cannot be an equilibrium. Equilibrium An equilibrium is a price or set of prices such that there is no excess demand or supply in the market. In the labor market, an equilibrium is a set of wages such that there is no excess demand or supply of workers to any firm. Example Any firm with an excess supply of workers wants to lower wages in order to lower costs and raise profits. – The clean, safe firm lowers its wage offer. Any firm with an excess demand for workers wants to raise its wage in order to attract more workers. – The dirty, noisy firm raises its wage offer.

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