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© 2002 McGraw-Hill Ryerson Ltd.Chapter 8-1 Chapter Eight Compensating Wage Differentials Created by: Erica Morrill, M.Ed Fanshawe College
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© 2002 McGraw-Hill Ryerson Ltd.Chapter 8-2 Chapter Focus Relative pay rates across jobs Different wages for identical skills Safety regulation Adequate compensation for unpleasant or risky jobs
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© 2002 McGraw-Hill Ryerson Ltd.Chapter 8-3 Theory of Compensating Wages Agreeableness/disagreeableness of job Ease/difficulty and expense of learning job Turnover in that position Degree of power and trust held Probability or improbability of success in job
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© 2002 McGraw-Hill Ryerson Ltd.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
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© 2002 McGraw-Hill Ryerson Ltd.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
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© 2002 McGraw-Hill Ryerson Ltd.Chapter 8-6 Different Firms with Different Safety Technologies Different abilities to provide safety at a given cost Different shaped isoprofit schedules for the same level of profit
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© 2002 McGraw-Hill Ryerson Ltd.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
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© 2002 McGraw-Hill Ryerson Ltd.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
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© 2002 McGraw-Hill Ryerson Ltd.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
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© 2002 McGraw-Hill Ryerson Ltd.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
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© 2002 McGraw-Hill Ryerson Ltd.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
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© 2002 McGraw-Hill Ryerson Ltd.Chapter 8-12 Figure 8.3 a Market Equilibrium Wages Safety ECEC UCUC ICIC Wc Sc Single Firm and Individual
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© 2002 McGraw-Hill Ryerson Ltd.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
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© 2002 McGraw-Hill Ryerson Ltd.Chapter 8-14 Figure 8.3 b Many Firms and Individuals Wages Safety Uc Ua Um Market Wage Safety Locus
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© 2002 McGraw-Hill Ryerson Ltd.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
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© 2002 McGraw-Hill Ryerson Ltd.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
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© 2002 McGraw-Hill Ryerson Ltd.Chapter 8-17 Alternative Portrayal Wage-risk model Risk is portrayed on the horizontal axis The same conclusions can be derived
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© 2002 McGraw-Hill Ryerson Ltd.Chapter 8-18 Figure 8.4 Wage-Risk Space Portrayal Wages Risk I3I3 I2I2 I1I1 U1U1 UmUm UaUa Market wage-risk locus
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© 2002 McGraw-Hill Ryerson Ltd.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
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© 2002 McGraw-Hill Ryerson Ltd.Chapter 8-20 Figure 8.5 a Response to Safety Standard Wc Sc Uc Ec Wr Sr Ur Er Ic Reduced Worker Utility
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© 2002 McGraw-Hill Ryerson Ltd.Chapter 8-21 Figure 8.5 b Response to Safety Standard Wc Sc Uc Ec Ic Reduced Employer Profits Wr Sr Ir
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© 2002 McGraw-Hill Ryerson Ltd.Chapter 8-22 Figure 8.5 c Response to Safety Standards Wage Safety U SrSr I1I1 I2I2 I3I3 Different Responses of different firms
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© 2002 McGraw-Hill Ryerson Ltd.Chapter 8-23 Imperfect Information If a worker misperceives utility than imposed safety standards could improve workers utility without making employers worse off Providing parties with correct information would also lead to optimal amounts of safety
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© 2002 McGraw-Hill Ryerson Ltd.Chapter 8-24 Figure 8.6 Effect of Imperfect Information WoWo SoSo UoUo EoEo Wage Safety UaUa SpSp UpUp WaWa SaSa SrSr
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© 2002 McGraw-Hill Ryerson Ltd.Chapter 8-25 Rationale for Regulation Information is not perfect Competition may not prevail Worker does not bear all the cost of an accident Social opinion Worker may prefer a safer environment
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© 2002 McGraw-Hill Ryerson Ltd.Chapter 8-26 End of Chapter Eight
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