Lecture Labour market economics: Chapter 8 - Dwayne Benjamin, Morley Gunderson, Craig Riddell

Chapter 8 - Compensating wage differentials. In this chapter, students will be able to understand: Relative pay rates across jobs, different wages for identical skills, safety regulation, adequate compensation for unpleasant or risky jobs.

Chapter Eight Compensating Wage Differentials  Created by: Erica Morrill, M.Ed           Fanshawe College © 2002 McGraw-Hill Ryerson Ltd Chapter 8-1 Chapter Focus  Relative pay rates across jobs  Different wages for identical skills  Safety regulation  Adequate compensation for unpleasant or risky jobs © 2002 McGraw­Hill Ryerson Ltd Chapter 8­2 Theory of Compensating Wages  Agreeableness/disagreeableness of job  Ease/difficulty and expense of learning job  Turnover in that position  Degree of power and trust held  Probability or improbability of success in job © 2002 McGraw­Hill Ryerson Ltd Chapter 8­3 Isoprofit Schedule  Combinations of wages and safety that the firm can provide and maintain the same level of profit  Exhibits a diminishing marginal rate of transformation between wages and safety  Lower curves imply higher levels of profits © 2002 McGraw­Hill Ryerson Ltd Chapter 8­4 Figure 8.1 a Isoproft Schedule Wage A Firm is providing little safety and can  provide additional safety in a relatively  inexpensive manner B Ih Firm is providing  considerable safety and can  provide additional safety  only through the introduction  of more sophisticated and  costly procedures Io © 2002 McGraw­Hill Ryerson Ltd Chapter 8­5 Safety Different Firms with Different Safety Technologies  Different abilities to provide safety at a given cost  Different shaped isoprofit schedules for the same level of profit © 2002 McGraw­Hill Ryerson Ltd Chapter 8­6 Different Firms with Different Safety Technologies Figure 8.1 b Wages I1 Firm Outer edge = Employer’s  offer or market envelope W2 W1 I2 S* Firm Safety © 2002 McGraw­Hill Ryerson Ltd Chapter 8­7 Employers’ Offer Curve  Maximum wages that will be offered for various levels of safety  Points within will not be offered because the other firm can offer a higher wage at the same level of safety  Employees will move to the firm supplying the highest wage for each level of safety © 2002 McGraw­Hill Ryerson Ltd Chapter 8­8 Individual’s Preferences  Illustrated by an isoutility 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 © 2002 McGraw­Hill Ryerson Ltd Chapter 8­9 Figure 8.2 W Worker Indifference Curves Single individual A B UO S Uh W Two individuals Less risk adverse Ub More risk adverse Ua S © 2002 McGraw­Hill Ryerson Ltd Chapter 8­10 Figure 8.3 a Market Equilibrium Single Firm and Individual Wages Wc EC IC Sc UC Safety © 2002 McGraw­Hill Ryerson Ltd Chapter 8­12 Equilibrium with Many Firms  Assuming perfect competition and information  individuals will sort themselves into firms of different risks  receive compensating wages  Wage-safety locus  various equilibrium combinations of wages and safety © 2002 McGraw­Hill Ryerson Ltd Chapter 8­13 Figure 8.3 b Many Firms and Individuals Wages Uc Ua Market Wage  Safety Locus Um Safety © 2002 McGraw­Hill Ryerson Ltd Chapter 8­14 Compensating Wage  Employers will adopt the most costeffective safety standards  not necessarily the safest  saving on compensating wages by increasing their safety  Termed “shadow” or “implicit” prices because they are embedded in the market wage © 2002 McGraw­Hill Ryerson Ltd Chapter 8­15 Characteristics of WageSafety 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 © 2002 McGraw­Hill Ryerson Ltd Chapter 8­16 Alternative Portrayal  Wage-risk model  Risk is portrayed on the horizontal axis  The same conclusions can be derived © 2002 McGraw­Hill Ryerson Ltd Chapter 8­17 Figure 8.4 Wage-Risk Space Market wage-risk Portrayal U locus m Wages Ua U1 I1 I2 I3 Risk © 2002 McGraw­Hill Ryerson Ltd Chapter 8­18 Effect of Safety Regulation  Perfect Competitive Markets  regulation requiring an increased level of safety would cause one or both parties to be worse off © 2002 McGraw­Hill Ryerson Ltd Chapter 8­19 Figure 8.5 a Response to Safety Standard Reduced Worker Utility Ic Wc Ec Uc Er Wr Sc Ur Sr © 2002 McGraw­Hill Ryerson Ltd Chapter 8­20 Figure 8.5 b Response to Safety Standard Ir Reduced Employer Profits Ic Wc Ec Uc Wr Sc Sr © 2002 McGraw­Hill Ryerson Ltd Chapter 8­21 Figure 8.5 c Wage Response to Safety Standards I1 Different Responses of different firms I2 U I3 Sr Safety © 2002 McGraw­Hill Ryerson Ltd Chapter 8­22 Imperfect Information  If a worker misperceives utility than 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 © 2002 McGraw­Hill Ryerson Ltd Chapter 8­23 Figure 8.6 Effect of Imperfect Information Wage Wa Wo Eo U Uo p Ua Sa So S Sr Safety p © 2002 McGraw­Hill Ryerson Ltd Chapter 8­24 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 © 2002 McGraw­Hill Ryerson Ltd Chapter 8­25 End of Chapter Eight © 2002 McGraw­Hill Ryerson Ltd Chapter 8­26 ... Figure 8. 4 Wage-Risk Space Market wage-risk Portrayal U locus m Wages Ua U1 I1 I2 I3 Risk © 2002 McGraw­Hill Ryerson Ltd Chapter 8 18 Effect of Safety Regulation  Perfect Competitive Markets  regulation... © 2002 McGraw­Hill Ryerson Ltd Chapter 8 16 Alternative Portrayal  Wage-risk model  Risk is portrayed on the horizontal axis  The same conclusions can be derived © 2002 McGraw­Hill Ryerson Ltd Chapter 8 17 Figure 8. 4... © 2002 McGraw­Hill Ryerson Ltd Chapter 8 11 Figure 8. 3 a Market Equilibrium Single Firm and Individual Wages Wc EC IC Sc UC Safety © 2002 McGraw­Hill Ryerson Ltd Chapter 8 12 Equilibrium with Many