Suppose that there is an excess supply of economics professors. Should universities necessarily reduce salaries? What does standard economic theory suggest? What does efficiency-wage theory suggest?

Answer 1

Standard economic theory suggests that if universities are interested in maximizing profits or minimizing costs, they should reduce salaries until the quantity supplied of workers is equal to the quantity demanded. The reduction in wages would reduce the costs of production and raise profits while still allowing universities to fill faculty positions.

Efficiency-wage theory suggests that it might be profitable for universities to keep wages above the equilibrium level in order to reduce worker turnover, increase worker quality, increase worker effort (reduce shirking) and therefore worker productivity. (Fortunately, salaries of economics professors are usually a bit above what is necessary to eat nutritious diets, so the worker-health variant of the efficiency wage is not likely to be important here.)