Chapter Summary

While the discussion of 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 be expected to 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, but integrated "labour market."

Wages will be higher for some individuals in order to compensate them for doing unpleasant jobs (or incurring additional costs of employment), while others will willingly accept lower pay for jobs with more amenities.

The model of compensating wage differentials can be applied to any job characteristic, but the most common application is workplace safety. 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. In the broader labour market, however, the competition between firms for workers will imply that for any level of safety, the technologically highest possible wage will be offered, while firms earn zero economic profits. The resulting "menu" of wage-safety combinations is called the employers' offer curve.

Workers have preferences over combinations of wages and workplace safety. Obviously, they would like more of both, but at any level of utility workers are willing to accept some additional risk in exchange for higher wages. Not all workers have the same attitudes toward workplace risk, and will put different values on workplace safety. Workers will sort across firms according to their relative tastes for wages or safety. Those who are least tolerant of risk will choose to work for those firms offering more safety, at the price of lower wages, while those who are less concerned about safety will work at the riskier, but higher-paying jobs.

In comparing wages across jobs with different levels of safety, the resulting equilibrium choices of workers and firms will yield a "market wage-safety locus." Given that most workers value safety (i.e., on the margin are willing to buy some additional safety in the form of lower wages at some price), and that 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, that wages will be lower for safer jobs all else equal.

Empirical analysis of compensating wage differentials attempts to estimate the extent to which wage differentials across individuals reflect differences in workplace XXXamenities, such as job safety. However, it is difficult to hold everything — such as XXXproductivity — constant when doing this analysis, and typically we observe higher-paid individuals also XXXhaving more job amenities. Nevertheless, most carefully executed studies find that wages are indeed higher (on average) for individuals with more dangerous or unpleasant jobs.

Primarily as a byproduct of the underlying assumptions of perfect competition and perfect information (workers choose the optimal amount of safety given technological constraints), the theory of compensating differentials can be used to show that government regulation of workplace safety will make workers worse off. However, if the government is more informed about workplace risks than workers, it is possible that government regulation of safety can improve the welfare of workers.