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December 13, 2017 

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GROSS DOMESTIC PRODUCT, INCOME: A method of estimating gross domestic product (GDP) based on identifying the income (wages, rent, interest, and profit) received by the owners of the four factors of production (labor, capital, land, and entrepreneurship). This is one of two methods used by the Bureau of Economic Analysis in the National Income and Product Accounts to estimate gross domestic product.

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COMPENSATING WAGE DIFFERENTIALS:

Different wages paid to different workers or in different markets that adjust for differences in the jobs or in the productivity of the workers. Wage differentials occur for many reasons. Quite often they are the result of the personal preferences of workers. In some cases workers are willing to "buy" leisure-time or other types of household production by taking lower wages. Differences in job risks, education, and location are also reasons for the persistence of wage differentials.
Wage differentials observed in the labor market are often compensating wage differentials. Some employers find it necessary to pay higher wages to compensate workers for dirty, dangerous, and generally undesirable working conditions. Other employers can pay less for comparable work because conditions are more pleasant.

Three reasons for compensating wage differentials are worth noting:

  • Risk and Hazardous Conditions: Jobs that are riskier, more dangerous, and have a greater likelihood of injury, typically pay higher wages. For example, coal miners, deep sea divers, and security guards are likely to be paid higher wages than similar jobs due to the hazardous nature of their duties.

  • Education and Skill: Jobs that require more education, skill, and training also tend to pay higher wages. Higher wages compensate for greater productivity and provide returns on investment in education and training.

  • Location: Jobs that are at undesirable, more distant, or hard to reach locations also pay higher wages. Firms in cities that have high living costs, inhospitable climates, high crime rates, or other "disamenities" find it necessary to offer higher wages to attract workers.
Compensating wage differentials have an important allocative function for the economy for two reasons:
  • First, they provide incentives for people to undertake less desirable work. If society decides that resources need to be allocated to production that involves undesirable work, then compensating wage differentials are necessary. Without extra wages, this work is not done.

  • Second, they provide incentives for employers to reduce the undesirable nature of the work. If otherwise identical firms have different working conditions, then one is forced to pay higher wages to attract workers. Higher labor cost encourages employers to improve working conditions to remain competitive.
As long as workers have complete information about the risks and hazards of a job and are free to choose between different employers, then compensating wage differentials are allocatively efficient. This is important in terms of government worker safety regulations--primarily undertaken by the Occupational Safety and Health Administration (OSHA).

A key function of OSHA is to reduce the amount of risk that workers face. However, some workers undertake more risky jobs to receive higher compensating wages. If the amount of risk is reduced, then so too are the wages (and presumably the welfare) of these workers. By attempting to help workers, OSHA can actually make them worse off.

Of course, if the labor market is not competitive and does not have well-informed workers, then job-related risks do not generate compensating wage differentials. Such is the case for jobs that use new and untested technologies. For example, the risks of coal mining and deep sea diving are well known and generate relatively high compensating wages. However, the risks of working for extended periods with computer video screens or recently developed chemicals are not yet known.

While wage differentials can enhance efficiency, they can also inhibit efficiency. When caused by discrimination, union market power, or government policies, wage differentials create inefficiencies in the economy.

<= COMPARATIVE STATICSCOMPENSATION OF EMPLOYEES =>


Recommended Citation:

COMPENSATING WAGE DIFFERENTIALS, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2017. [Accessed: December 13, 2017].


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