Chapter 8 Compensating Wage Differentials and Labor Markets

Important Definitions - Job Matching üPecuniary and Non Pecuniary Job Characteristics ü“Bad” Jobs vs. “Good” Jobs üCompensating Wage Differentials üPositive Differentials and Negative Differentials üTesting the Theory of Compensating Wage Differentials Copyright © 2009 Pearson Education, Inc. 8 - 2

A Simple Theory of Job Choice If we assume that: 1. Workers maximize utility, not income 2. Workers are aware of work conditions 3. Workers have a range of jobs to choose from Then… Copyright © 2009 Pearson Education, Inc. 8 - 3

A Simple Theory of Job Choice “All other things equal, employees in bad working conditions will receive higher wages than those working in more pleasant conditions. ” What are the “all other things” that we are assuming to be equal in making this prediction? Copyright © 2009 Pearson Education, Inc. 8 - 4

Hedonic Wage Theory and the Risk of Injury I Characteristics of the Employee Indifference Curve üRepresent Levels of Wages and Risks That Yield Same Level of Utility üCurves Are Positively-Sloped üCurves to the Northwest Represent Higher Levels of Utility üCurves Are Concave From Above - Diminishing Marginal Utility üIndividuals Differ in Their Attitude Toward Risk üIndividuals Try to Achieve Highest Level of Utility Copyright © 2009 Pearson Education, Inc. 8 - 5

Figure 8. 1: A Family of Indifference Curves between Wages and Risk of Injury

Figure 8. 2: Representative Indifference Curves for Two Workers Who Differ in Their Aversion

Hedonic Wage Theory and the Risk of Injury I Characteristics of Isoprofit Curves üRepresent Levels of Wages and Risks That Yield a Given Level of profit üCurves Are Positively-Sloped üCurves Are Concave From Below - Diminishing Marginal Returns to Safety Expenditures üFirms Will Operate on the Zero-Profit Curve üSome Firms Can Reduce Risk more Cheaply Than Others Copyright © 2009 Pearson Education, Inc. 8 - 8

Figure 8. 3: A Family of Isoprofit for an Employer Copyright © 2009 Pearson

Figure 8. 4: The Zero-Profit Curves of Two Firms Copyright © 2009 Pearson Education,

Figure 8. 5: Matching Employers and Employees Copyright © 2009 Pearson Education, Inc. 8

Hedonic Wage Theory and the Risk of Injury I Characteristics of Offer Curves üShows the Offers That Firms Can Afford to Make That Are Acceptable to Workers üOffers Along Only the Most Northwest Segments Are Acceptable to Workers Copyright © 2009 Pearson Education, Inc. 8 - 12

Figure 8. 6: An Offer Curve Copyright © 2009 Pearson Education, Inc. 8 -

Major Conclusions of Hedonic Wage Theory 1. Wages rise with risk 2. Workers with strong preferences for safety will 3. take jobs with firms where safety can be 4. generated most cheaply Copyright © 2009 Pearson Education, Inc. 8 - 14

Occupational Safety and Health Act 1. Is there a need for workplace regulation? 2.

Figure 8. 7: The Effects of Government Regulation in a Perfectly Functioning Labor Market

Using Cost-Benefit Analysis to Evaluate Workplace Regulation Benefits: How much are workers willing to sacrifice for a given reduction in risk? Costs: How much do firms have to reduce wages to reduce risk, while keeping profits constant? Copyright © 2009 Pearson Education, Inc. 8 - 17

Hedonic Wage Theory and Employee Benefits I Why Employee Pay For Their Own Benefits üPayments in Kind üDeferred Compensation and Tax Advantages üThe Employee’s Wage/Benefit Indifference Curve üThe Employer’s Wage/Benefit Isoprofit Curve üThe Offer Curve and Determination of Wages and Benefits Copyright © 2009 Pearson Education, Inc. 8 - 18