Ch' 8: Compensating Wage Differentials

1
Lecture 7

• Ch. 8 Compensating Wage Differentials
• Theory of compensating wage differentials
• Effect of safety regulation
• Empirical evidence
• Policy implications

2
Wage distribution
Wage Rate ()
Probability distribution
WU
WE
Supply
WL
Demand
NE
NH
NL
Number of Workers
3
Compensating wage differentials

• What job attributes (besides low pay) do people
  dislike?
• What job attributes (besides high pay) do people
  like?
• Were you compensated for the poor working
  conditions?
• If yes, said to have received a compensating wage
  differential.

4
Compensating wage differentials (contd)

• Conditions necessary for existence of CWD.
• Alternative job opportunities exist
• Mobility between jobs
• Perfect information
• Your dislike of the job attribute isnt unique

5
Heterogeneous preferences
Income per day ()

UB



Slope -WRB


UA

Slope -WRA
T
Leisure (hours/day)




6
Heterogeneous preferences (contd)
Wage
Supply
RB
RA
1
2
Number of Workers
7
Compensating wage differential (contd)
Relative Wage (WB/WA)
W1
SupplyB
Compensating Wage Differential
W0 1
DemandB
N1
Employment in occupation B
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Compensating wage differential (contd)
Relative Wage (WB/WA)
Supply1
W2
W0 1
D2
D1
N1
N2
Number of Workers
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Compensating Wage Differentials (contd)

• Compensating wage differentials have serve three
  socially desirable purposes
• Long history in economic thought
• The five following are the principal
  circumstances which, so far as I have been able
  to observe, make up for a small pecuniary gain in
  some employments, and counter-balance a great on
  in others first, the agreeableness or
  disagreeableness of the employments themselves
  secondly, the easiness and cheapness, or the
  difficulty and expense of learning them thirdly
  the constancy or inconstancy of employment in
  them fourthly, the small or great trust which
  must be reposed in those who exercise them and
  fifthly, the probability or improbability of
  success in them.

10

Wage differentials for dangerous work

• Compensating risk premium
• Why analyze this type of wage differential
• Development and insights of model

11
One Persons Indifference Curves
Wage
Utility2
Utility1
C
B
WB
A
WA
RA
RB
Risk of injury
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Indifference Curves of Two People
Wage
UtilityA
UtilityB
E
W2A
W2B
F
D
W1
R1
R2
Risk of injury
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One Persons Indifference Curves
Wage
Utility2
Utility1
Safety
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Indifference Curves of 2 people
Wage
W2A
W2B
W1
Utility B
UtilityA
S1
S2
Safety
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Isoprofit schedules

• What do isoprofit schedules depict?
• Why negative tradeoff between safety and wages?
• How does tradeoff change with increasing amount
  of safety?

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Isoprofit Schedules for One Firm
Wage
A
B
IHIGH
ILOW
Safety
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Isoprofit Schedules for 2 firms
Wage
W1
W2B
W2A
I Firm A
I Firm B
S1
S2
Safety
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Isoprofit Schedules (contd)
Wage
WA1
WB1
W1
I Firm A
I Firm B
SB1
SA1
S1
Safety
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Equilibrium One worker one firm
Wage
W1
U 1
I1
Safety
S1
20
Equilibrium 2 firms and 2 workers
Wage
W2
UB
UA
W1
S1
S2
Safety
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Safety regulation Effect on worker
Wage
WC
U1
Wr
U2
I1
Safety
SC
Sr
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Safety regulation Effect on firm
Wage
I2
I1
WC
Wr
U1
Safety
SC
Sr
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Rationale for Safety Regulation

• Information is not perfect
• Worker mobility may not exist
• Worker does not bear all the cost of an accident
• Social opinion
• Workers may prefer a safer environment

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Empirical Evidence

• Compensating risk premiums
• How to determine if compensating wage
  differentials actually exist?
• Gunderson and Hyatt (2001)

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Empirical Evidence (contd)
Injuries by Selected Industry in Canada, 1998
Source Human Resources Development Canada (2000)
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Empirical Evidence (contd)

• Gunderson and Hyatt (2001) (contd)
• Used multivariate regression.
• Wage f (risk of death, risk of injury, age,
  education, work experience, union membership,
  occupation, firm size, region)
• How do risk or death and risk of injury affect
  wages?
• Findings

27

Empirical Evidence (contd)

• Hatton and Williamson (1991)
• What is relationship between jobs with high risk
  of unemployment and wages?
• Looked at data on unskilled labourers from
  Michigan in the 1890s
• Found strong evidence of compensating wage
  differentials
• Implications

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Empirical Evidence (contd)
Source www.jobquality.ca (part of www.cprn.org)
29
Empirical Evidence (contd)
Source www.jobquality.ca (part of www.cprn.org)
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Empirical Evidence (contd)
Source Frank, 1996
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Empirical Evidence (contd)
Source www.jobquality.ca (part of www.cprn.org)