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The Compensation Wage Differentials

Updated on November 22, 2018

Labor Markets: High & Low Risk Jobs

The Wage Compensating Differentials
Compensation is a lot more than paid wages. It’s typically one of the biggest expenses companies make when hiring their employees. These expenses include; bonuses, stock options, merit rewards, base pay (hourly or salary wages), sales (commission), overtime and such benefits as (insurance, standard vacation, retirement) other cash and non-cash rewards. Compensation is defined as the total amounts of cash and non-cash payments made to workers in exchange for labor in the market. The theory of compensating wage differentials, originally conceived by Adam Smith suggests: Jobs with disagreeable characteristics; with all other things equal, more so command higher wages. Today, firms offer different working working conditions for their workers. While workers exhibit different preferences. Consider for example; that there are only two types of jobs in the labor market. Some are safe (less hazardous) and others are risky (more hazardous) jobs. Workers prefer different job characteristics. Those who are looking for a particular set of work environments, search the market for the firms providing such working conditions.

The theory of compensating wage differentials describes how these two sides “match and mate” in the labor market. Workers in a way that’s characteristic display different attitudes towards risks. The greater a worker’s dislike of risk (more hazardous) jobs; the greater the bribe he/she demands for switching from a safe (less hazardous) job to a more risky (hazardous) job, thus the greater the amount of money it would take to bribe he/she into accepting the risky (more hazardous) occupation. Much as workers decide on whether to accept job offers from risky (more hazardous) firms or more safe (less hazardous) firms; a firm must also decide on whether to provide a risky (more hazardous) or a safe (less hazardous) working condition for it’s workers. The choice depends on what is more profitable.

When the demand for workers in more risky working environments are small, there is a negative compensating wage differential for such workers in the labor market. In turn; firms might get away with paying a lower wage for their workers in more risky occupations. Some workers like the risk. In fact; we can expect workers (race car drives, explorers) to derive a certain level of utility from similar occupations. It means workers are also willing to pay for the right to work in risky working conditions. The market compensating wage differentials is negative when there’s very little demand for such workers in the labor market. Workers maximize utility by choosing a wage-to-risk combination which offers them the greatest amounts of utility.

The labor market binds workers-to-firms; those who dislike risk correspond more with firms that find it convenient to provide a safe working condition for their workers. While the same is true for workers who do not mind the risk as much to that of firms which find it challenging to complement safe working conditions. In short; as long as all persons in a population agree on whether a certain job characteristic is (good, bad) some jobs are associated with lower wages, whereas others are considered to compensate more higher rewards


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