The document discusses compensating wage differentials, which arise when wages are higher for jobs with less desirable characteristics, such as dangerous working conditions, in order to compensate workers. It provides examples of how firms that offer riskier jobs must pay higher wages to attract workers. This ensures there are incentives for workers to take on dangerous jobs and penalties for firms that offer poor working conditions. Workers and firms tend to match based on their preferences - firms offering safer jobs attract workers who highly value safety, while riskier firms attract workers more focused on wages.

1. Compensating Wage Differentials
Course: MBA-1
Subject: ME
Unit:2.5
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2. 5.1 Introduction
The model of competitive labor
markets implies that as long as
workers or firms can freely enter
and exit the marketplace, there
will be a single wage in the
economy if all jobs are same
and all workers are same.
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3. 5.1 Introduction
 The labor market is not characterized by a
single wage: workers differ and jobs differ.
 Adam Smith proposed the idea that job
characteristics influence labor market.
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4. 5.1 Introduction
 Compensating wage differentials arise to
compensate workers for nonwage
characteristics of the job.
 Workers have different preferences and
firms offer different working conditions.

5. 5.2 Workers’ and Firms’ Choice with
Risky Jobs
E.g.
Employer X: NT.$100 per hour, clean,
safe work conditions
Employer Y: NT.$100 per hour, dirty,
noisy factory
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6. 5.2 Workers’ and Firms’ Choice with Risky Jobs
→ Most workers would undoubtedly
choose employer X.
If employer Y decides not to alter
working conditions, it must pay wage
above NT.$100 to be competitive in
the labor market.

7. 5.2 Workers’ and Firms’ Choice with Risky Jobs
→ The extra wage it must pay to attract
workers is called a compensating wage
differential because the higher wage is
paid to compensate workers for the
undesirable working conditions.
After the wage rise of firm Y, if both firms
could obtain the quantity and quality of
works they wanted, the wage differential
would be an equilibrium differential, in the
sense that there be no forces causing the
differential to change.

8. The Compensating Wage Differential Serves
Two Purposes
 It serves a social need by giving people
an incentive to voluntarily do dirty,
dangerous, or unpleasant work or a
financial penalty on employers offering
unfavorable working conditions.
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9. The Matching of Employer and
Employees
 Since X can produce safety more cheaply than Y, X
will be a low-risk producer who attracts employees,
like A, who value safety highly. Y attracts people like B,
who have a relatively strong preference for money
wages and a relatively weak preference for safety.
Note:

10. Major Insights
1. Wages rise with risk, other things equal.
→ There will be compensating wage differentials
for job characteristics that are viewed as
undesirable by workers.
2. Workers with strong preferences for safety will
tend to take jobs in firms where safety can be
generated most cheaply.
→ Firms and workers offer and accept jobs in a
fashion that makes the most of their strengths
and preferences.
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11. Summary
 The worker’s price gives the wage
increase that will persuade the worker to
accept a job with an unpleasant
characteristic, such as the risk of injury.
 The worker will switch to a riskier job if
the market-compensating wage
differential exceeds the worker’s prices.

12. Summary
 Firms choose whether to offer a risky
environment or a safe environment to
their workers.
 Firms that offer a risky environment must
pay higher wages; firms that offer a safe
environment must invest in safety.
 The firm offers whichever environment is
more profitable.

13. Summary
 The market compensating wage differential is
the Rupees amount required to convince the
worker (that is, the last worker hired) to move
to the riskier job.
 If a few workers enjoy working in jobs that
have a high probability of injury and if these
types of jobs demand relatively few workers,
the market wage differential will go the
"wrong" way. In other words, risky jobs will pay
lower wages than safe Jobs.

14. Summary
 There is a "marriage" of workers and firms in
the labor market. Workers who dislike
particular job characteristics (such as the risk of
injury) match with firms that do not
offer those characteristics; workers who like the
characteristics match With firms that
provide them.
 The value of life can be calculated from the
relation between the worker's wage and
the probability of injury on the job.

15. Summary
 Workers with high earnings potential are
likely to earn more and to have more
generous job benefits.

16.  Source:
 Manquee book managerial economics.
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