| Referenced figures and exhibits can be found in your textbook. While the discussion in Chapters 1 to 7 emphasized that everyone in the labour market is paid the same wage, wages clearly vary across individuals. This chapter develops the tools to show why wages can differ across individuals (even if everyone is equally productive) when the labour market comprises sub-markets that are integrated into a single, more broadly defined labour market Wages structures, the relative prices of labour, are utilized to allocate labour to its most productive use and to encourage human capital development (such as education) into areas yielding the highest return In addition, higher wage rates compensate workers for undesirable job characteristics and ensure the equality of supply and demand for such (undesirable) jobs Theory of Compensating Wages
The idea of compensating wage differentials can be traced back to the writings of Adam Smith: "the agreeableness or disagreeableness of the employment themselves... make up for a small pecuniary gain in some employments" Higher wage rates compensate workers for undesirable working conditions, such as an unsafe or unhealthy work environment or undesirable working hours (the midnight shift), and for incurring additional costs of employment - wages will be higher for some individuals to compensate them for doing unpleasant jobs, while others will willingly accept a lower wage for jobs with more amenities
Workplace safety can be used to illustrate the theory of compensating wage differentials; the risk of injury or illness that can result form an unsafe or unhealthy work environment gives rise to compensating wage differentials Firms can choose their production technology to offer workers greater safety or they can economize on safety and offer the savings to workers in the form of higher wages; for any firm, there will generally be a tradeoff in offering more safety or higher wages, holding constant the level of profits - Figure 8.1(a) illustrates a single firm's isoprofit schedule showing various combinations of wages and safety that the firm can offer and maintain the same level of profit
Different firms have different abilities to provide safety at a given cost and thus different firms will have differently shaped isoprofit schedules (see Figure 8.1(b)) Given the competition between firms for workers, the technologically highest possible wage will be offered for any level of safety - as illustrated in Figure 8.1(b), the resulting "menu" of wage-safety combinations is called the employers' offer curve (or market envelope curve) and shows the maximum compensating wage that will be offered for various levels of safety
As with any other items individuals value, workers have preferences for wages and workplace safety, which can be illustrated by a typical indifference curve showing various combinations of wages and safety that yield the same level of utility (see Figure 8.2(a)) - obviously, workers would like more of both wages and safety, but at any level of utility workers are willing to accept some additional risk in exchange for a higher wage rate
But not all workers have the same attitudes toward workplace risk and different workers will put different values on workplace safety - as shown in Figure 8.2(b), a more risk-averse individual requires a larger compensating wage differential in return for giving up some safety and accepting a riskier work environment
Figure 8.3(a) illustrates the market equilibrium position for the case of a single firm and an individual - the individual maximizes utility subject to the firm's zero economic profit constraint; given the individual's preferences, the equilibrium compensating wage Wc is the highest the firm is able to offer for the level of safety Sc
Figure 8.3(b) illustrates the market equilibrium that will prevail when there are many firms and individuals - assuming perfect competition, workers will sort themselves into firms (occupations and industries) of different safety/health risks (along the market envelope schedule) and receive differing compensating wage rates for different levels of risk
- individuals who are not very concerned about safety will enter a high-risk firm in order to get a higher wage, such as WL in Figure 8.3(b), which is associated with a low level of safety, SL; individuals who are less tolerant of risk will choose to work for those firms offering more safety, such as SH, at the price of lower wages, WH
- as shown in Figure 8.3(b), the set of tangencies between the various isoprofit and indifference schedules gives the market wage-safety locus, the various equilibrium combinations of wages and safety that will prevail in the market
- the slope of the wage-safety locus shows the rate at which the market compensates individuals for working in less safe conditions
- given that most workers value safety (i.e., on the margin they are willing to buy some additional safety in the form of lower wages at some price) and safety is costly for firms to supply, we expect that the wage-safety locus will show a negative relationship between wages and safety, that is, wages rates will be lower for safer jobs all else equal
Given perfect information and perfect competition, the market will pay a compensating wage premium for undesirable (risky) working conditions - this will induce workers to sort themselves into jobs depending upon their aversion to risk and will induce employers into adopting the most cost-effective safety standards (not necessarily the safest) since they can save on compensating wages by increasing safety
Empirical studies of compensating wage differentials have attempted to estimate the extent to which wage differentials across individuals reflect differences in workplace amenities, such as job safety - most carefully executed studies find that wage rates are higher on average for individuals with more dangerous or unpleasant jobs (see textbook pages 233 - 237 for a discussion of the empirical evidence on compensating wage differentials)
The Effect of Safety Regulation The effect of safety regulation depends critically upon whether markets are operating properly, or not, to compensate workers for occupational risk Given perfect competition and perfect information, the theory of compensating wage differentials implies that workers will choose the optimal amount of safety - in Figure 8.5(a), the level of safety Sc is socially optimal in the sense that a compensating wage differential Wc ensures that neither employers or employees want to move from the level of safety Sc (to do so would make one or both parties worse off)
As illustrated in Figure 8.5, under competitive market conditions and perfect information, government regulation that increases the level of safety from Sc to Sr will make either workers or firms (or both parties) worse off - in Figure 8.5(a), the firm remains on its isoprofit curve with no reduction in profits but the worker is worse off as the regulated combination Er lies on a lower indifference curve Ur
- in Figure 8.5(b), the worker remains on his/her indifference curve with no loss in utility but the safety regulation forces the firm onto a higher iso-profit curve with reduced profits
- realistically, the cost of safety regulation will likely be borne by both workers in the form of compensating wage reductions and firms in the form of lower profits
The assumption of perfect information about the level of safety may be unrealistic in situations where employers have a vested interest in not disclosing information about health hazards and where there is a long latency period before an occupational disease shows up In such circumstances, if the government is more informed about workplace risks than workers, it is possible that government safety regulations can improve the welfare of workers without making firms worse off - as illustrated in Figure 8.6, workers may think that they have a higher level of safety (and hence a higher level of perceived utility) for the compensating wage differential they actually receive
- given such circumstances, a government regulation to increase the level of safety (to a level higher that Sa but lower than Sr) can increase actual utility without reducing profits (by moving down the iso-profit schedule)
For information about occupational health and safety, click-on
http://www.ccohs.ca/ | 
2002 McGraw-Hill Higher Education