Econ 381
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ECON 381. Compensating differentials. We have talked about how workers care about non-wage job characteristics

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ECON 381

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Econ 381

ECON 381

Compensating differentials


Econ 381

  • We have talked about how workers care about non-wage job characteristics

  • We also talked about the “fixed wage” model, in which the straight-time wage adjusts to offset the overtime premium. The idea is that workers care about the overall value of their compensation package

  • What is the relationship between non-wage job characteristics and wages? Do lousy jobs pay more to compensate workers for bad conditions? How are non-wage job characteristics priced in the labour market?


Workers preferences

Workers’ preferences

  • Consider a job that has two characteristics, a wage and something else (e.g. safety, hours of work, prestige),. Let’s take the example of risk, R.

  • Both of the characteristics affect workers’ utility:


Indifference curves

Indifference curves

  • Negative slope

  • Convex

  • Don’t cross

  • U0>U1>U2

W

U0

U1

U2

S


Indifference curves1

Indifference curves

Who is more risk-averse?

A is willing to give up more wages than B in exchange for a given increase in safety.

A values safety more, i.e. she is more risk-averse.

W

S


Firms iso profit functions

Firms’ iso-profit functions

W

S


Firms iso profit functions1

Firms’ iso-profit functions

Which firm can provide

safety least expensively?

Firm B requires a larger reduction in the wage rate to offset the costs of providing one more unit of safety.

B can provide safety least expensively.

W

S


Equilibrium one firm one worker

Equilibrium – one firm, one worker

  • Competitive equilibrium – firms make zero profits

  • Equilibrium at tangency point

W

W*

S

S*


Equilibrium two firms two workers

Equilibrium – two firms, two workers

Which worker is matched with which firm?

Why?

Person A likes safety more. She is matched to Firm A, which can provide safety at lower cost.

W

S


Equilibrium many firms many workers

Equilibrium – many firms, many workers

Locus of tangencies traces out hedonic relationship between wages and safety.

Slope of hedonic relationship is the market price of safety.

W

S


Minimum safety standards

Minimum safety standards

Minimum safety standard = Smin.

W

S

Smin


Minimum safety standards1

Minimum safety standards

Minimum safety standard = Smin.

W

S

Smin


Minimum safety standards2

Minimum safety standards

Minimum safety standard = Smin.

Firm C goes out of business.

W

S

Smin


Minimum safety standards3

Minimum safety standards

Minimum safety standard = Smin.

Worker C gets lower utility.

W

S

Smin


Minimum safety standards4

Minimum safety standards

  • Does this mean that occupational health and safety regulations are a bad idea?

Prof. Simon D. Woodcock


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