Chapter 7 The Wage Structure
What makes equality such a difficult
business is that we only want it with our
superiors.
—Henry Becque
7.1 Perfect Competition: Homogenous
Workers and Jobs
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Homogenous Workers and Jobs
7.2 The Wage Structure: Observed
Differential

Hourly Earnings By Occupational Group,
2006
7.2 The Wage Structure: Observed
Differential

Hourly Earnings By Industry Group, 2006
7.2 The Wage Structure: Observed
Differential

Private Manufacturing Worker’s Hourly
Earnings By State, 2006
7.3 Wage Differentials: Heterogenous Jobs
Compensating Differentials
 Compensating wage differentials consist of
extra pay that an employer must provide a
worker for some undesirable job characteristic
that does not exist in alternative employment.
 The wage differential is caused by a
decreased labor supply for the job that has the
undesirable job characteristic and an
increased labor supply for the alternative
employment.
7.3 Wage Differentials: Heterogenous Jobs
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Compensating Differentials
Sources of compensating differentials
Risk of job injury or death
Riskier jobs pay higher wages
Fringe benefits
Jobs with greater fringe benefits pay lower
wages
Job status
Jobs with greater prestige pay lower wages
7.3 Wage Differentials: Heterogenous Jobs
Compensating Differentials
 Job location
 Cities with greater amenities pay lower wages.
 Cities with greater cost of living pay higher
nominal wages.
 Job security
 Jobs with greater job security pay lower wages.
 Prospect of wage advancement
 Jobs with greater wage advancement have
lower starting wages.
7.3 Wage Differentials: Heterogenous Jobs
Compensating Differentials
 Extent of control over the work place
 Jobs with less personal control over the
workplace and less flexible work hours
pay higher wages.
7.3 Wage Differentials: Heterogenous Jobs
Differing Skill Requirements
 Jobs that require more education and training
will pay a higher wage rate than those that do
not.
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The wage difference between skilled and unskilled
workers is called the skill differential.
Skill differentials can increase, decrease, or
reverse wage differences caused by
compensating differentials.

Example: Nurses earn more than ditch diggers
7.3 Wage Differentials: Heterogenous Jobs
Efficiency Wage Payments
 Shirking model
 Firms will pay above-market wages where it is
costly to monitor employee performance or the
employer’s cost of poor performance is high.
 Turnover model
 Firms will pay above-market wages when
hiring and training costs are high.
 Empirical evidence
 There is mixed empirical evidence
7.3 Wage Differentials: Heterogenous Jobs
Other Job or Employer Heterogeneities
 Union status
 Union workers earn more than nonunion
workers.
 Most of the differential is an economic rent to
union workers.
 Discrimination
 Discrimination against women and minorities
exists in some markets and creates wage
differentials.
7.3 Wage Differentials: Heterogenous Jobs
Other Job or Employer Heterogeneities
 Firm size
 Large firms pay higher wages than small firms.
 Large firms are more likely to be unionized.
 Workers at large firms may be more productive
 Training, better workers, greater capital
 Higher wages may be a compensating wage
differential.
7.4 Wage Differentials: Heterogenous Workers
NonCompeting Groups
 Individuals differ in the type, amount, and
quality of their human capital.
 The result is the labor force consists of
noncompeting groups of workers that are not
easily substitutable for each other.
 In the short run, these differences in human
capital generate wage differentials.
 In the long run, the wage differentials cause
individuals to move to higher paying jobs to
some extent.
7.4 Wage Differentials: Heterogenous Workers
Differing Preferences
 Differences in time preferences
 Persons who are presented-oriented (i.e., have a high
discount rate) are not willing to sacrifice present
consumption without a large increase in future income.
 Persons who are future-oriented (i.e., have a high
discount rate) are willing to sacrifice present
consumption for a small increase in future income.
 Persons with lower discount rates acquire more
human capital and thus create wage differentials.
7.4 Wage Differentials: Heterogenous Workers
Differing Preferences
 Differences in time preferences
 Persons who are presented-oriented (i.e., have a high
discount rate) are not willing to sacrifice present
consumption without a large increase in future income.
 Persons who are future-oriented (i.e., have a high
discount rate) are willing to sacrifice present
consumption for a small increase in future income.
 Persons with lower discount rates acquire more
human capital and thus create wage differentials.
7.4 Wage Differentials: Heterogenous Workers
Differing Preferences
 Differences in tastes for nonwage
aspects of jobs
People have different preferences for job
security, location, and risk.
 These differences in preferences create
wage differentials
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7.5 The Hedonic Theory of Wages

Indifference Map
7.5 The Hedonic Theory of Wages
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Isoprofit Curve
7.5 The Hedonic Theory of Wages

Matching
7.5 The Hedonic Theory of Wages
Labor Market Implications
 Workers with fewer nonwage amenities will get higher
wages.
 Laws with minimum safety standards may reduce
utility of some workers.
 Risk loving workers would prefer higher wages to
greater safety.
 Part of the male-female wage differential may reflect
differences in preferences for nonwage amenities.
 Women may prefer shorter commuting distances and
safer jobs.
7.5 The Hedonic Theory of Wages
Labor Market Implications
 Workers with strong preferences for
fringe benefits will match up with firms
that can provide fringe benefits at low
cost.
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Cafeteria plans which allow workers to
choose from a variety of fringe benefits
allow workers to get higher utility since they
are not forced to accept a fixed bundle
7.6 Wage Differentials: Labor market
Imperfections

Wage Rate Distributions
7.6 Wage Differentials: Labor market
Imperfections

Lengthy Adjustment Period
7.6 Wage Differentials: Labor market
Imperfections
Immobilities
 Labor immobilities are impediments to the movement
of labor and can cause wage differentials.
 Geographic immobilties
 Costs to moving can deter migration and thus permit
wage differentials to exist across geographic areas.
 Institutional immobilties
 Restrictions on mobility imposed by the government or
unions can deter mobility.
 Occupational licensing, apprenticeships
7.6 Wage Differentials: Labor market
Imperfections
Immobilities
 Sociological immobilties
 Race and gender discrimination will
cause racial and gender wage
differentials to exist.