Presentation on theme: "Chapter 8 Compensating Wage Differentials. What affects occupational choice? wages non-pecuniary characteristics since jobs have both of these attributes,"— Presentation transcript:
What affects occupational choice? wages non-pecuniary characteristics since jobs have both of these attributes, people face tradeoffs between them
Compare two jobs - - Both pay $7.50/hour Firm X is offering an office job as a file clerk Firm Y is an asphalt company who needs workers to help pave roads Which firm will attract more applicants at a wage of $7.50? What will have to happen at Firm Y to attract more workers?
The extra wage that is paid to attract workers into paving roads is called the compensating wage differential workers require "combat pay" for undesirable working conditions on the other hand, the pleasant atmosphere of desirable jobs must be bought by the workers through lower pay
Compensating Wage Differentials the price at which various qualitative job characteristics are bought and sold “BADS” result in positive differentials (higher wages) “GOODS” result in negative differentials (lower wages)
Holding worker characteristics constant, employees in “bad” jobs receive higher wages than those working under more pleasant conditions.
What are these worker characteristics? skill age sex race marital status education geographic region union status
We will assume: workers maximize utility workers have perfect information about their jobs workers have mobility
Utility Maximization if we used income maximization, the worker would take the highest paying job regardless of attributes this is likely not the case with most workers
Perfect Information workers are aware of the job characteristics and the wages paid this may not always be true for example, workers did not use to know the adverse effect of asbestos
Worker Mobility workers have a range of jobs to choose from and can look for a new job while working median job tenure in the U.S. is 3.5 years
When graphing worker preferences for wages vs. job characteristics, we use indifference curves we will put the wage on the y-axis we will put the risk of injury on the x-axis since risk is a “bad”, these indifference curves will have an unusual shape the indifference curves will be upward- sloping and convex
The indifference curves will be upward-sloping to accept more risk, an individual will require a higher wage to remain equally satisfied this is because the worker’s utility is lowered if they incur an injury
Isoprofit curves are upward-sloping since reducing risk is costly to the firm, it will be willing to pay higher wages as jobs become more risky thus, there should be a positive relationship between risk and wage reflected in the isoprofit curve
00 w0w0 R0R0 w1w1 R1R1 A B A firm is equally profitable at A or B. Note that higher risk allows the firm to pay higher wages.
Isoprofit curves are concave this is due to diminishing marginal returns to reducing risk at first, firms will use safety measures that can be done so most easily and inexpensively the more safety measures employed by a firm, the more expensive and difficult additional measures will be
00 w0w0 R0R0 w1w1 R1R1 Risk can be reduced more cheaply at R 1 than R 0
11 w0w0 R0R0 22 Firms with steeper isoprofit curves find it more costly to reduce risks.
11 w0w0 R0R0 w1w1 R1R1 22 w2w2 To reduce risk from R 0 to R 1 and keep profit constant, Firm 1 would have to lower wages only to w 1 while Firm 2 would have to lower wages to w 2. Thus, Firm 1 can reduce the risk at lower relative cost.
The zero profit isoprofit curve is most often the only relevant isoprofit curve. Why?
Equilibrium occurs where the isoprofit curve is tangent to the indifference curve this means that the slope of the isoprofit curve is equal to the slope of the indifference curve the rate at which the firm is able to trade wages for risk is equal to the rate at which workers are willing to trade wages for risk
Wages Rise With Risk workers with strong preferences for safety are willing to accept lower wages workers with strong preferences for safety will take jobs where safety can be generated at a lower cost
How do government programs controlling risk affect workers’ utility? The federal government set safety standards for many occupations through OSHA (Occupational Safety and Health Administration)
Suppose a firm is threatened with large fines by the government if they do not comply to safety standards. If the firm complies with the standards, are the workers better off? not if the workers know the risks the workers may be better off if they are unaware of the risks we can use our model to show this
What happens when the worker does not know the true level of risk? In this case, government intervention can make the worker better off
Unknown Risk Suppose a worker receives a wage of w 0 and thinks that the risk level is R 0 the worker thinks that his utility level is U 0 but, if the actual risk is R a, the actual utility level is U a
w0w0 R0R0 U0U0 The worker thinks that he is at point G G 00
W0W0 R0R0 U0U0 RaRa 00 But the worker is actually at point A... AG
w0w0 R0R0 U0U0 RaRa UaUa …at utility level U a 00 G A
Government intervention can help in this case if the government sets the allowable risk level between R a and R b,workers will actually end up on a higher indifference curve. the workers may perceive that they are worse off (because their wage will be lower) when in fact they have been made better off (because the level of risk has been reduced)