Efficiency Wage

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Description of Efficiency Wage. Explanation.

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Definition Efficiency Wage. Description.


Why are many employers paying salaries or wages above the minimal rate as determined in the market? The phenomenon  is explained by the economic concept called the Efficiency Wage hypothesis. Simply put, employers get more if they pay more: the increased labor productivity pays for the relatively higher wages.


Actually, there are multiple Efficiency Wages models (theories that explain why wages are often above a supply = demand clearing rate):

  • Inhibit Shirking. It is not easy to measure the quantity or quality of a worker's effort. There may be an incentive for employees to "shirk" (do less work than agreed). Managers may pay a premium in order to create or increase the cost of job loss, which gives a sting to the threat of firing. This threat can be used to prevent shirking (or "moral hazard").

  • Reduce Labor Turnover. By paying a premium, the costs can be decreased of searching, recruiting and training replacement workers, should an employee decide to quit and seek a job elsewhere.

  • Adverse Selection. Firms with higher wages might attract more able job-seekers. The employer can select the best.

  • Create a sense of Obligation. Efficiency wages may simply result from traditions. Higher wages encourage high morale and increases Organizational Commitment, which raises productivity.

  • Avoid unobserved ill discipline. In poor countries, efficiency wages may allow workers to eat well enough to avoid illness and Work Absenteeism and to be able to work harder and more productively.

  • Corporate Responsibility. The need or want to be fair or to be a good citizen of society.


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