Chapter Eight Compensating Wage Differentials Learning Objectives Relative Pay Rates Across Jobs Different Wages for Identical Skills Regulation Adequate Compensation for Unpleasant or Risky Jobs Prepared by Dr. A. Noordeh York University Assisted by I. Bershad Chapter 8 2007 McGraw-Hill Ryerson Ltd. 1 Chapter 8 2007 McGraw-Hill Ryerson Ltd. 2 Theory of Compensating Wages Factors affecting compensation for wages: Agreeableness/disagreeableness of job Ease/difficulty and cost of learning job Turnover in a particular job Degree of power and trust held Probability or improbability of success in job risks involved in performing the job Compensating Wages and Isoprofit Schedule (IP): Combinations of wages and safety that the firm can provide and maintain the same level of profit IP curve exhibits a diminishing marginal rate of transformation between wages and safety Lower curves imply higher levels of profits Chapter 8 2007 McGraw-Hill Ryerson Ltd. 3 Chapter 8 2007 McGraw-Hill Ryerson Ltd. 4 1
Wage Isoprofit Schedule Firm is providing little safety and can provide additional safety in a relatively inexpensive manner A Firm is providing considerable safety and can provide additional safety only through the introduction of more sophisticated B and costly procedures Different Firms with Different Technologies Different firms have different abilities to provide safety at a given cost and, hence, there are different isoprofit curves for the same level of profit for different firms. I h I o Chapter 8 2007 McGraw-Hill Ryerson Ltd. 5 Chapter 8 2007 McGraw-Hill Ryerson Ltd. 6 Different Firms with Different Technologies Individual s Preferences Wages W 2 W 1 Firm 1 I 1 Outer edge = Employer s offer Curve or market envelope I Firm 2 2 Illustrated by an iso-utility (indifference) curve combinations of safety and wage that yield the same level of utility Different risk preferences May be willing to give up safety for a compensating risk premium S* Chapter 8 2007 McGraw-Hill Ryerson Ltd. 7 Chapter 8 2007 McGraw-Hill Ryerson Ltd. 8 2
W Worker Indifference Curves Single individual Two individuals W Less risk averse A B W 0 U h U O U b More risk averse U a Equilibrium with Single Firm and a Single Individual Tangency between the iso-utility curve and the isoprofit curve Yields the optimal wage and safety level S 0 Chapter 8 2007 McGraw-Hill Ryerson Ltd. 9 Chapter 8 2007 McGraw-Hill Ryerson Ltd. 10 Market Equilibrium Equilibrium with Many Firms W Wc E C Sc Single firm and single individual U C I C Assuming perfect competition Individuals will sort themselves into firms of different risks receive compensating wages Wage-safety locus various equilibrium combinations of wages and safety Chapter 8 2007 McGraw-Hill Ryerson Ltd. 11 Chapter 8 2007 McGraw-Hill Ryerson Ltd. 12 3
Wages Many Firms and Many Individuals Least risk-averse Uc Employer s offer curve Ua Wage-safety locus Um Most risk averse Chapter 8 2007 McGraw-Hill Ryerson Ltd. 13 Characteristics of the Wage- Locus Slope is negative compensating wages are required for reductions in safety The slope can change for different levels of safety Determined by the workers preferences and the firms technology for safety Chapter 8 2007 McGraw-Hill Ryerson Ltd. 14 Effect of Regulation Response to Standard Perfectly Competitive Markets regulation requiring an increased level of safety would cause one or both parties to be worse off Wages Ic Wc Ec Reduced Worker Utility Uc Wr Sc Er Sr Ur Chapter 8 2007 McGraw-Hill Ryerson Ltd. 15 Chapter 8 2007 McGraw-Hill Ryerson Ltd. 16 4
Response to Standard Response to Standards Wage Wage Ir Reduced Employer Profits I 1 Different Responses of different firms Wc Wr Ic Ec Uc I 2 Sc Sr Chapter 8 2007 McGraw-Hill Ryerson Ltd. 17 U I 3 S r Chapter 8 2007 McGraw-Hill Ryerson Ltd. 18 Imperfect Information If a worker misperceives the utility, then the imposed safety standards could improve workers utility without making employers worse off Providing parties with correct information would also lead to optimal amounts of safety Effect of Imperfect Information Wage W a W o E o U p U o U a S a S o S p S r Chapter 8 2007 McGraw-Hill Ryerson Ltd. 19 Chapter 8 2007 McGraw-Hill Ryerson Ltd. 20 5
Rationale for Regulation Information is not perfect Competition may not prevail Worker does not bear all the cost of an accident Social opinion Worker may prefer a safer environment Summary Wage differentials in an integrated labour market Wage differences related to factors other than productivity aspects of jobs A model of compensating wage differentials Work safety and workers attitude towards work place risk Market wage-safety locus The impact of government regulation of work place safety Chapter 8 2007 McGraw-Hill Ryerson Ltd. 21 Chapter 8 2007 McGraw-Hill Ryerson Ltd. 22 End of Chapter Eight Chapter 8 2007 McGraw-Hill Ryerson Ltd. 23 6