Differences in Wages: Study with Video Lessons, Practice Problems & Examples

Wage differences arise from factors like compensating differentials, where less pleasant jobs pay more, and human capital, which reflects education and training levels. Employers may also offer efficiency wages above equilibrium to incentivize productivity, increasing job retention. Additionally, "superstars" earn high wages due to derived demand for their unique skills in lucrative markets, contrasting with lower wages in fields like education where supply exceeds demand. Understanding these concepts helps clarify wage structures and market dynamics.

Differences in Wages:Compensating Differential and Human Capital

Alright, so now let's consider some of the reasons why different jobs might pay different amounts of money or even people working in the same job might be making different amounts of money. Let's see why. So not all jobs are created equal, right? Some jobs are going to be easy, some are hard, and some aspects of a job may be unpleasant. Okay? So this first reason why we might see a difference in wages, the compensating differential. This rewards a worker for taking a less pleasant job. Okay. Less pleasant can mean any number of things. One good example is a construction worker. Construction workers take on, say, a riskier job, right? They're working with heavy machinery, heavy labor, right, physical labor that they have to do all day and they're working in tall buildings so they're taking a riskier job, they're going to have to be compensated for that, right? So that's going to be a higher wage based on that riskiness. So let's take on this kind of silly example here I've got. We've got Nice Guy Nick and Angry Andy, who are the two guys who own a flower shop in this town, and you could imagine that everything's going to be the same about both of their flower shops except for the management. Management at Angry Andy's shop, well, he's angry, he yells at you all the time, so it's more unpleasant to work for Angry Andy. Right? So you might see that Nice Guy Nick might be able to pay a wage of $10 an hour where Angry Andy might have to pay $12 an hour because people have to put up with his anger, right? So you might think if you had to pick, if you had the choice to work for Nice Guy Nick or Angry Andy, well, now you'd have to make a decision. Is it worth the extra $2 an hour to put up with Angry Andy? Well, that's the compensating differential, right? Those extra $2, that's the compensating differential for this unpleasantness at the job. Okay? So this is kind of a silly example, but you can see how it works here. Alright. So let's go on to the next one here. Human capital. So we've talked about human capital before. Right? This is one of the factors of production here, and human capital, well, it represents the education and training of the workforce, right? They're going to be more productive when they're more educated and they have more training, so you could imagine if you have higher human capital, if you've gone to college, if you've gone to a technical school, something like that, well you're going to get a higher wage, right, because you have some education, you have some training, and the opposite, right? You've got lower human capital, well you're going to get a lower wage, right? Okay. So that one's pretty simple, pretty straightforward. Why don't we stop right here and in the next video we'll go over another couple of examples of why there might be differences in wages, right? Let's do that now.

Differences in Wages:Efficiency Wages and Superstars

Alright, so another reason we might see a difference in wages is that the employer purposely pays a wage above equilibrium. They know the equilibrium wage, but they're going to purposely pay above that as an incentive to the employee. Okay, it's going to be an incentive to the employee to work harder, to be more productive. A wage above the equilibrium, so this wage that this employer is paying as an incentive, we call it an efficiency wage. They're paying that wage because they want more efficiency out of their employees. Cool?

Alright, so let's kind of follow the logic of what's happening here. In the employee's mind, well, if they have an efficiency wage job, say they're paying $15 an hour when the equilibrium wage is $10 an hour. Well, the opportunity cost of losing the job is higher, right? You have a higher opportunity cost of losing this efficiency wage job because if you had lost this job, now you're losing $15 an hour rather than $10 an hour. So, you want to hold on to the job a little more because of that reason. And it likely follows that if you're fired from this efficiency wage job, well, you might have to accept a lower-paying job. Right? You might not be able to find another efficiency wage job and you could imagine that these efficiency wage jobs allow the employer to have more people coming to them, right? They're paying above equilibrium, so you could imagine they're going to have a surplus of supply, a lot of people coming to them, and they can pick the best employee.

Alright, so in this sense, the workers are going to be motivated to perform well to avoid being fired. That efficiency wage gets the workers to be more efficient. Cool?

The last one here we're going to talk about on this page is superstars. So, how do superstars make so much money, right? If you think of professional athletes, movie stars, music stars, right? They're all making tons of money, but how are they making so much more than other jobs? Well, it depends on the demand for the good being sold. The good being sold is going to show what the wage is going to be for the people producing the good. Remember that demand for labor is derived from the good being produced.

So let's first think about professional athletes. Well, professional football players create football games. That's the good. The good is the football game and the professional football players create that game and those games can be sold at a very high price. They fill arenas, sell lots of tickets, merchandise, this and that, there's a lot of money to be made off of these professional football players, but what you're going to see is that the supply of professional football players is low. There's not so many people qualified to play professional football, but the demand for these football players is really high. So, with this high demand, low supply, you can imagine that the equilibrium wage can get really high up there, especially with the product being sold for tons of money just like football games are.

Okay, now let's compare that to a high school teacher. High school teachers create educational products and those products are sold at a very low price. The football games are sold at a really high price, but the educational products are usually sold really low. When you think about a high school, well, they're usually just funded by the government, right? There's not tons of money going into this. So the supply of high school teachers, people qualified to teach high school, well, there's a much higher supply of these high school teachers, and the demand for high school teachers comparatively is going to be low. So, we're going to see that the equilibrium wage for high school teachers is going to be much lower than the equilibrium wage for professional football players. They're working in different markets with different goods being sold.

Alright, so that's about it for this page. We're going to talk about one more topic of differences in wages and we're going to talk about discrimination. Alright, so let's see that in the next video.

Here’s what students ask on this topic:

What is a compensating differential in wage theory?

A compensating differential refers to the additional amount of income that a worker receives to compensate for the unpleasant aspects of a job. This concept explains why some jobs pay more than others despite requiring similar skill levels. For example, a construction worker might earn a higher wage due to the physical risks and labor involved, compared to a less risky office job. The extra pay compensates for the job's unpleasantness, such as danger, stress, or undesirable working conditions. This differential ensures that workers are willing to take on less pleasant roles by making the financial reward more attractive.

How does human capital affect wage differences?

Human capital refers to the education, training, and experience that workers possess, which enhances their productivity. Higher human capital typically leads to higher wages because more educated and trained workers can perform tasks more efficiently and effectively. For instance, a college graduate is likely to earn more than a high school graduate due to the additional skills and knowledge acquired through higher education. Conversely, workers with lower human capital, such as those with less education or training, tend to earn lower wages. Thus, investment in human capital is a key factor in determining wage differences.

What is an efficiency wage and why do employers pay it?

An efficiency wage is a wage rate that is deliberately set above the market equilibrium by employers to boost worker productivity and reduce turnover. By offering higher wages, employers incentivize employees to work harder and remain with the company longer, as the opportunity cost of losing the job is higher. For example, if the equilibrium wage is $10 per hour, an employer might pay $15 per hour to ensure that employees are more motivated and less likely to leave. This strategy can lead to a more efficient and stable workforce, ultimately benefiting the employer.

Why do superstars like athletes and actors earn significantly higher wages?

Superstars such as athletes and actors earn significantly higher wages due to the high demand for their unique skills and the lucrative markets they operate in. The demand for their services is derived from the high value of the goods they produce, such as sports events or movies, which can generate substantial revenue through ticket sales, merchandise, and broadcasting rights. Additionally, the supply of individuals with the necessary talent and skills to perform at this level is very limited. This combination of high demand and low supply results in exceptionally high wages for superstars.

How does discrimination contribute to wage differences?

Discrimination in the labor market can lead to wage differences by unfairly disadvantaging certain groups of workers based on characteristics such as race, gender, or ethnicity. Discriminatory practices can result in these workers receiving lower wages, fewer job opportunities, and limited career advancement compared to their equally qualified counterparts. This can occur through biased hiring practices, unequal pay for equal work, and barriers to promotions. Addressing discrimination requires implementing fair employment practices, promoting diversity, and enforcing anti-discrimination laws to ensure that all workers are compensated based on their skills and productivity rather than personal characteristics.