ECON 381 Compensating differentials

 We have talked about how workers care about non-wage job characteristics  We also talked about the “fixed wage” model, in which the straight-time wage adjusts to offset the overtime premium. The idea is that workers care about the overall value of their compensation package  What is the relationship between non-wage job characteristics and wages? Do lousy jobs pay more to compensate workers for bad conditions? How are non-wage job characteristics priced in the labour market?

Workers’ preferences  Consider a job that has two characteristics, a wage and something else (e.g. safety, hours of work, prestige),. Let’s take the example of risk, R.  Both of the characteristics affect workers’ utility:

Indifference curves  Negative slope  Convex  Don’t cross  U 0 >U 1 >U 2 S W U2U2 U1U1 U0U0

Indifference curves Who is more risk-averse? A is willing to give up more wages than B in exchange for a given increase in safety. A values safety more, i.e. she is more risk-averse. S W

Firms’ iso-profit functions S W

S W Which firm can provide safety least expensively? Firm B requires a larger reduction in the wage rate to offset the costs of providing one more unit of safety. B can provide safety least expensively.

Equilibrium – one firm, one worker S W  Competitive equilibrium – firms make zero profits  Equilibrium at tangency point S* W*

Equilibrium – two firms, two workers S W Which worker is matched with which firm? Why? Person A likes safety more. She is matched to Firm A, which can provide safety at lower cost.

Equilibrium – many firms, many workers S W Locus of tangencies traces out hedonic relationship between wages and safety. Slope of hedonic relationship is the market price of safety.

Minimum safety standards S W Minimum safety standard = S min. S min

Minimum safety standards S W Minimum safety standard = S min. S min

Minimum safety standards S W Minimum safety standard = S min. Firm C goes out of business. S min

Minimum safety standards S W Minimum safety standard = S min. Worker C gets lower utility. S min

Minimum safety standards  Does this mean that occupational health and safety regulations are a bad idea? Prof. Simon D. Woodcock