Efficiency Wage

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What is an Efficiency Wage? Meaning.

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.

The term Efficiency Wages (aka "Efficiency Earnings") was coined by English Economist Alfred Marshall to denote the wage per efficiency unit of labor. He calculated an efficiency wage using efficiency or ability exerted being the unit of measure rather than time. In other words, a more efficient worker will be paid more than a less efficient worker for the same amount of hours worked.

Lately the term is used somewhat differently. It now refers to the economic idea that higher wages increase the efficiency of the workers due to various reasons, making it worthwhile for companies to offer wages that exceed a market-clearing level. The optimal efficiency wage is reached at the point where the marginal cost of an increase in wages is equal to the marginal benefit of the improved productivity to an employer.

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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🔥 10 Reasons Why Firms are Offering Above Average Salaries and Perks
Employers get more if they pay more... Beyond the reasons for this already mentioned in the summary of Efficiency Wages, below I listed 10 key reasons for and effects of offering Efficiency Wages (abo...
topic Quotes on Salaries. Quotations
Hi, do you know of a remarkable, humorous quote by a famous person or a proverb related to paying (high) salaries?Please enter a reaction to share it for other people to enjoy! "It is not the emplo...
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Compare with: Opportunity Cost  |  Value for Money Audit  |  Cost-Benefits Analysis  |  Expectancy Theory  |  Two Factor Theory  |  Employee Attitude Survey

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