What is the theory of efficiency wages? Provide four reasons that employers might pay efficiency wages

Answer 1

According to the theory of efficiency wages, firms operate more efficiently if wages are above the equilibrium level. Therefore, it may be profitable for firms to keep wages high even in the presence of an excess supply of labor. If so, firms will keep wages above the equilibrium level, creating unemployment.

(1) Worker Health:
Better-paid workers eat a more nutritious diet, and workers who eat a better diet are healthier and more productive. A firm may find it profitable to pay higher wages in order to have healthier, more productive workers.

(2) Worker Turnover:
The more a firm pays its workers, the less often its workers choose to leave the firm. Since it is costly to hire and train new workers, it may be profitable for an employer to pay higher than equilibrium wages in order to reduce worker turnover rates.

(3) Worker Effort:
In jobs where workers have some discretion over how hard they work, workers may shirk. As a result, firms monitor the effort of their workers, and those caught shirking are fired. However, it is costly to monitor workers, and monitoring is often imperfect. By paying higher wages, firms make it more expensive for workers to shirk, since if they are caught they will not readily find other employment at their current wage. It may be profitable for a firm to pay higher than market wages in order to reduce shirking.

(4) Worker Quality:
When a firm hires new workers, it cannot perfectly gauge the quality of the applicants. By paying a higher wage, the firm attracts a better pool of workers to apply for its jobs. It may be profitable for a firm to pay higher than market wages in order to increase the probability that it will hire good-quality workers.