Chapter 8-1 Chapter Eight Compensating Wage Differentials Modified from Slides Created by: Erica Morrill

Chapter 8-2 Chapter Focus  Relative pay rates across jobs  Different wages for identical skills  Safety regulation  Compensation for unpleasant or risky jobs

Chapter 8-3 Theory of Compensating Wages  Explain why some workers are paid more and others less, although their qualifications may be identical. Factors include:  1. Risk/safety (our focus)  2. Turnover in that position (e.g., Jobs in public and private sectors)  3. Probability of success in job

Chapter 8-4 Isoprofit Schedule  Combinations of wages and safety that the firm can provide and maintain the same level of profit  Exhibits a diminishing marginal rate of transformation between wages and safety  Lower curves imply higher levels of profits

Chapter 8-5 Figure 8.1 a Isoproft Schedule A Firm is providing little safety and can provide additional safety in a relatively inexpensive manner B Firm is providing considerable safety and can provide additional safety only through the introduction of more sophisticated and costly procedures Wage Safety IhIh IoIo

Chapter 8-6 Different Firms with Different Safety Technologies  Different abilities to provide safety at a given cost (cause: different industries using different technologies)  Different shaped iso-profit schedules for the same level of profit

Chapter 8-7 Figure 8.1 b Different Firms with Different Safety Technologies Wages Safety I1I1 Firm 1 I2I2 Firm 2 Outer edge = Employer’s offer or market envelope W1W1 S* W2W2

Chapter 8-8 Employers’ Offer Curve  Maximum wages that will be offered for various levels of safety  Points within will not be offered because the other firm can offer a higher wage at the same level of safety  Employees will move to the firm supplying the highest wage for each level of safety

Chapter 8-9 Individual’s Preferences  Illustrated by an isoutility curve  combinations of safety and wage that yield the same level of utility  Different risk preferences  May be willing to give up safety for a compensating risk premium

Chapter 8-10 Figure 8.2 Worker Indifference Curves W S W S Single individual Two individuals UOUO UhUh A B UbUb UaUa Less risk adverse More risk adverse

Chapter 8-11 Equilibrium with Single Firm and a Single Individual  Tangency between the isoutility curve and the isoprofit curve  Yields the optimal wage and safety level

Chapter 8-12 Figure 8.3 a Market Equilibrium Wages Safety ECEC UCUC ICIC Wc Sc Single Firm and Individual

Chapter 8-13 Equilibrium with Many Firms  Assuming perfect competition and information  individuals will sort themselves into firms of different risks  receive compensating wages  Wage-safety locus  various equilibrium combinations of wages and safety

Chapter 8-14 Figure 8.3 b Many Firms and Individuals Wages Safety Uc Ua Um Market Wage Safety Locus

Chapter 8-15 Compensating Wage  Employers will adopt the most cost- effective safety standards  not necessarily the safest  saving on compensating wages by increasing their safety  Termed “shadow” or “implicit” prices because they are embedded in the market wage

Chapter 8-16 Characteristics of Wage- Safety Locus  Slope is negative  compensating wages are required for reductions in safety  The slope can change for different levels of safety  Determined by the workers’ preferences and the firms technology for safety

Chapter 8-17 Alternative Portrayal  Wage-risk model  Risk is portrayed on the horizontal axis  The same conclusions can be derived

Chapter 8-18 Figure 8.4 Wage-Risk Space Portrayal Wages Risk I3I3 I2I2 I1I1 U1U1 UmUm UaUa Market wage-risk locus

Chapter 8-19 Effect of Safety Regulation  Perfect Competitive Markets  regulation requiring an increased level of safety would cause one or both parties to be worse off

Chapter 8-20 Figure 8.5 a Response to Safety Standard Wc Sc Uc Ec Wr Sr Ur Er Ic Reduced Worker Utility

Chapter 8-21 Figure 8.5 b Response to Safety Standard Wc Sc Uc Ec Ic Reduced Employer Profits Wr Sr Ir

Chapter 8-22 Figure 8.5 c Response to Safety Standards Wage Safety U SrSr I1I1 I2I2 I3I3 Different Responses of different firms

Chapter 8-23 Imperfect Information  If a worker misperceives utility U p (that results from misperceived S p, given W a ) then any imposed safety standards (between S a and S r ) could improve workers utility without making employers worse off (see Fig.8.6)  Providing parties with correct information would also lead to optimal amounts of safety ( W o, S o )

Chapter 8-24 Figure 8.6 Effect of Imperfect Information WoWo SoSo UoUo EoEo Wage Safety UaUa SpSp UpUp WaWa SaSa SrSr

Chapter 8-25 Rationale for Regulation  Information is not perfect  Competition may not prevail  Worker does not bear all the cost of an accident (with OHIP, government bears the costs  Worker may prefer a safer environment

Chapter 8-26 End of Chapter Eight