ch. 8: compensating wage differentials and labor markets a compensating wage differential –an...
TRANSCRIPT
Ch. 8: COMPENSATING WAGE DIFFERENTIALS AND LABOR MARKETS
• A compensating wage differential – an increment in wages required to attract workers into
a job with an undesirable working condition.
• Theory of Compensating differences. – Assumptions on Employee Side.
• workers maximize utility.• workers know job attributes and competing job offers.• workers are mobile.
wage
risk (or other "bad")
I1I2I3
• Employee preferences– Indifference curves to the NW represent higher levels
of utility.– A flatter indifference curve reflects a greater
willingness to accept money to put up with additional risk (less risk averse)
Assumptions on Employer Side.• Firms maximize profits.• Iso-profit curves show combinations of wage and risk that yield same
profit.• Iso-profit curves further to the SE represent higher levels of profits.
• A steeper iso-profit curve indicates that it is more costly to eliminate
risk.wage
risk
IS0
IS1
IS2
OPTIMAL NEGOTIATIONS OVER WAGES AND RISK
• If the company and worker negotiate A, how could they both be made better off?
• If the company and worker negotiate B, how could they both be made better off?
• At what point will all the possible gains from negotiation be eliminated?
IS0
I1
A
B
MATCHING OF WORKERS AND FIRMS.
A1, A2, B1, B2 represent worker indifference curves.
X’ and Y’ represent zero profit iso-profit curves for firms X and Y
(Recall: in competitive product markets, profits are always driven to zero since firms enter/exit whenever profits are positive/negative)
• How do workers A and B compare in terms of their attitude toward risk?
• How do firms X and Y compare in terms of their costs of eliminating risk?
• If both firms offer R’ (on zero profit line)– Can firm X renegotiate a wage/risk contract that would leave
their profits unchanged but be preferred to worker A? worker B? How would the contract differ?
– Can firm Y renegotiate a wage/risk contract that would leave their profits unchanged but be preferred to worker A? worker B? How would the contract differ?
• Which type of workers get matched to X firms? Y firms?
AN ALTERNATIVE APPROACH: LABOR SUPPLY/LABOR DEMAND
Assume: • All workers can receive W0 in NR job where
there is no risk.• Workers have varying degrees of aversion to
risk on R jobs.• Least risk averse person is indifferent between
NR and R job.• What does labor supply curve for R jobs look
like?
• What is compensating difference for risk on R job?
• In terms of risk aversion, which workers end up in R job?
• Which workers are receiving “rents” for putting up with risk on R jobs?
• Which area in above diagram represents the “rents”?
• What happens in above diagram if workers become more risk averse?
• Under what conditions would firms with R jobs find it profitable to eliminate risk?
• If firms eliminated the risk, what would happen to wages in R jobs?
• Empirical application: OSHA mandates elimination of risk on R jobs.– are workers in X jobs better or worse off? by
how much?– are firms with R jobs better or worse off?– are consumers that buy products from R
better or worse off?– Other considerations:
• worker information.• worker mobility.• competitive nature of labor market.• externalities (e.g. insurance, family members)
Value of Life and Compensating Differences
• qa ( qb) =probability of fatal injury on job a, b in a given year.
• Wa ( Wb) = earnings on job a, b in a given year.
• Assume qa<qb so that Wa<Wb.
• Compensating difference=Wb-Wa
• Value of a “statistical” life = (Wb-Wa)/(qb-qa)
• Example: If a person is faced with .001 higher risk of death per year and is paid $5000 per year extra for that risk, the value of a statistical life is 5000/.001 - $5,000,000.
Viscusi. “The Value of a Statistical Life: A Critical Review of Market Estimates Throughout the World.” Journal of Risk and Uncertainty, v. 27 issue 1, 2003, p. 5.
Value of Life and Compensating Differences
• Biases in estimates of statistical value of life– Valuation is correct only for “marginal” worker.
Estimate is too high for infra-marginal worker, and too low for workers that didn’t accept job with risk.
– ex post versus ex ante rewards for risk (compensating difference vs. law suits, insurance, etc.)
– Failure to control for other risks correlated with fatality risk
– Fatality risk measured with error
FRINGE BENEFITS AND COMPENSATING DIFFERENCES.
• If slope=-1, firm is indifferent between paying $1 as wages or fringes.
• If fringes are “productive”, firm may be willing to add more than $1 of fringes if employee accepts $1 cut in earnings (slope < -1)– employer tax consequences– deferred pay reduces turnover– worker selection
FRINGE BENEFITS AND COMPENSATING DIFFERENCES.
• If fringes are “counter-productive”, firm is willing to add more than $1 of wages if employee accepts $1 cut in benefits.– sick pay may encourage absenteeism.– administration of fringe benefits could be expensive
OPTIMAL ALLOCATION OF COMPENSATION BETWEEN WAGES AND FRINGES
• How do workers with indifference curves I0 and I1 compare in terms of their willingness to give up wages for fringes?
• If there were many firms in the market place, which firms would attract type 1 workers? type 0 workers?
• What if all firms were forced to offer the same fringe benefit package that was between what was optimal for type 0 and 1 workers. Which workers would be better off? worse off?