Compensating Wage Differentials

Question 1

Why do compensating wage differentials arise?

Answer 1

To compensate workers for

nonwage characteristics of the job

Question 2

Give some examples of characteristics that should bring compensation

Answer 2

Risk of injury on the job
Physically challenging
Mentally challenging
Polluted work environment
Inflexible working time/shift work

Question 3

When do workers accept a risky job?

Answer 3

When utility loss from switching from safe

to risky job more than compensated by the associated wage increase: U(w1, 1) > U(w0, 0)

Question 4

Define: reservation price

Answer 4

The minimum wage (increase) that makes

a worker accept the risky job

Question 5

When might a firm have a risky environment?

Answer 5

When it is less expensive to pay higher wages than to make the environment safe

Question 6

How does the marginal product of labor differ between safe and risky environments?

Answer 6

Safety does not come for free.

Firm has to allocate resources to ‘produce’ a safe environment

Diverting resources from the production of output

Marginal product of labor is higher in a risky environment (α1 > α0)

Question 7

Give three characteristics of the Hedonic Wage Function

Answer 7

Upward sloping: workers dislike risk and firms find costly to increase safety

Slope gives the unit market value of risk

At each point: slope of HWF equals the slope of the indifference curve, i.e. workers reservation price