442topic3 - Topic#3 CompensatingWageDifferentials...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
Topic #3                    Compensating Wage Differentials Compensating wage differentials are where people are paid more for dirty, dangerous, difficult, or dishonorable work. We’ll focus on how much more people get paid for dangerous worker where there is a risk of death on the job. The policy implications of this analysis pertain to safety regulations. If all working conditions were the same, then employees would work at the job with the highest wage. But, jobs differ. We will examine the way they differ in terms of wages and the incidence of being fatally injured on the job. U 2 Bob U 2 Bart U 1 Bob U 1 Bart Wages Risk of Death on the Job Indifference curves connect all the wage-safety combinations that yield the same utility. We assume three things about our indifference curves. First, we assume that employees maximize utility, not income. Second, we assume they have perfect information about the wages and risk involved with each job. Third, we assume that workers are mobile and can change jobs without cost. Bob and Bart have different preferences. Bob has five young children, he takes care of his invalid mother, and he loves to play sports. Consequently Bob is more risk averse. Therefore, Bob is willing to give up more in terms of wages to be safer. Bart is less risk averse. Bart has no family, no hobbies, but he enjoys saving money. Dangerous work is fine – Bart is willing to work dangerous jobs to earn more money.
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Notice that the marginal rate of substitution between wages and risk changes along the indifference curve. At point A, the worker is not willing to give up much in terms of wages to be safer because danger is practically nothing but the wage rate is relatively low. At point B, the worker is willing to give up a lot in terms of wages to be made safer because the worker is in relatively imminent danger. Thus, indifference curves should be convex (where the marginal rate of substitution increases as you move from left to right) because of a diminishing marginal rate of substitution. That is, the wages we’re willing to give up in order to be made safer decreases the safer we become.          U   Wages b W B a W A Risk A Risk B Risk of Death on the Job Isoprofit curves identify all the wage-safety combinations that yield the same level of economic profits. We assume three things about isoprofit curves. First, we assume that safety costs money. Second, we assume that firms will earn zero economic profits (along their zero economic profit isoprofit curve) in a long-run equilibrium. Third, we assume that other job characteristics are the same – the only things that varies across jobs are wages and safety. Firms that are able to eliminate danger relatively easily – at minimal cost – offer jobs that
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 11/20/2010 for the course ECONOMICS 331 taught by Professor Mj during the Fall '10 term at University of Alberta.

Page1 / 17

442topic3 - Topic#3 CompensatingWageDifferentials...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online