Wage differentialsCompensation Management

Prepared By

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Manu Melwin JoyAssistant Professor

Ilahia School of Management Studies

Kerala, India.Phone – 9744551114

Mail – manu_melwinjoy@yahoo.com

Wage differentials

• The wage paid to workers

varies greatly. These wage

differentials are mostly the

result of differences in

worker ability and the

workers' effort in performing

the job.

Wage differentials• There are also wage

differentials across occupations, because of differences in the demand and supply of laborers for particular job or occupation. These differences arise primarily because of differences in the amount of education or training required and in the desirability of the job itself.

Occupational Wage Differentials• Obviously, certain

occupations pay more than others. Surgeons make more than teachers, who make more than retail salespeople. Most of these wage differentials are the result of educational and training requirements, what is often referred to as human capital.

Occupational Wage Differentials• Surgeons require more

than a decade of education and training after high school before they can earn a living as surgeons, while retail salespeople can get a job right of the high school, or even while they are still in school.

Occupational Wage Differentials• Education and training limit the

supply of labor in that they take a certain amount of time to complete and require a certain level of skill. In many cases, people who attend college or training school do not have the time to work a full-time job. Therefore, they also incur an opportunity cost which is equal to the amount of money that they could have earned had it not been for the educational or training requirement.

Occupational Wage Differentials• Another primary factor that

determines wages is the demand for the worker, which is a derived demand for the product or service that the worker provides. If the worker provides a product or service that is highly desirable, then a higher wage will prevail for a given supply of workers who could do that job.

Occupational Wage Differentials• Sometimes, ability makes a

very large difference in wage potential that far outweighs the differences in ability. The winning horse earns a lot more than the one that comes in 2nd even though it is only a little faster. There are only so many jobs for professional athletes, so only the very best are going to be chosen for those high-paying jobs.

Occupational Wage Differentials• Likewise, only the best

musicians or those producing the most desirable music will become wealthy. People only have so much time and money for entertainment, so they tend to select entertainment performed by the best people, especially entertainment package for mass consumption.

Compensating Differentials

• Some jobs pay more

because they are less

desirable. They may be

hazardous, dirty, and

employment may be

sporadic or seasonal.

Compensating Differentials• For instance, construction

pays more than retail sales because of these compensating differentials, which are nonmonetary differences between jobs where higher or lower wages are paid because of differences in the desirability of the job itself.

Compensating Differentials• Most retail jobs take place in air-

conditioned or heated stores where the worker can wear nice clothing, stay clean, engage in friendly conversations with customers, and expend little physical effort. By contrast, construction workers may perform hazardous work, will become dirty during the job requiring them to spend additional time cleaning up afterwards, and will often have to work long hours to get the job finished, and they may not get work during the winter months. Hence, to attract enough workers to construction, the industry has to pay more.

Compensating Differentials

• In many cases, status or

power, or the lack thereof,

may also be a compensating

differential. After all, you

never hear a kid saying I

want to grow up to be a

garbage collector.

Compensating Differentials• On the other hand, much

more money is spent to elect someone to the presidency of the United States than they will ever earn at the job, and many lawyers make more than Supreme Court justices, yet few lawyers would turn down an appointment to the Supreme Court.

Wage Differentials Due to Locality

• For any given type of job,

wages are usually higher in

one locality than in others.

Much of this difference is

because of differences in the

cost-of-living.

Wage Differentials Due to Locality • However, most people are

reluctant to move because they do not want to leave their friends, sell their house, be subjected to the cost and uncertainty of a new job in a new community, and the children may not want to change schools.

Wage Differentials Due to Locality

• People may also be unwilling

to give up pension plans,

health insurance, or seniority

at their current job. Hence,

wage differentials in different

localities may persist, even if

people know that higher

wages can be earned

elsewhere.

Wage Differentials Due to Locality • The requirement for

occupational licensing may also be an impediment to moving to a different area for higher wages. Many occupations require state licensing, such as law and medicine, so if a licensed worker wanted to move to a new state, she would have to obtain a new license and may have to satisfy additional requirements.

Wage Differentials Due To Market Imperfections

• In economics, there is a presumption that people will migrate to higher paying jobs from lower paying jobs of the same type and with the same requirements. However, this can only happen if people know about the jobs.

Wage Differentials Due To Market Imperfections

• People tend to look for jobs in their own locality by searching the local newspaper or local Internet listings. Moreover, many people get jobs from their network of friends and acquaintances, who tend to live in the same area.

Wage Differentials Due To Market Imperfections

• Hence, the lack of

information can lead to

persistent differences in

wage differentials for the

same type of job.

Performance Pay• Many occupations pay a wage

rate that is commensurate with performance, such as sales or managerial occupations. The purpose of performance pay is to attract the most highly qualified and productive workers, or as economists like to say, workers with highest marginal revenue productivity.

Performance Pay• Performance pay is also used

to motivate workers to work. Many employees paid a flat wage rate often linger or dawdle, which lowers their productivity and the employer's marginal revenue product. Dawdling employees can also lower morale, since harder working employees resent being paid the same as the dawdling employees.

Performance Pay

• Performance pay helps to

solve this principal-agent

problem by aligning the

interests of the employees

with that of the owners of

the firm — both want to

make more money.

Performance Pay

• There are various types of

performance pay. Piece rates

are paid according to the

amount of work

accomplished. Many

factories use piece rates to

prevent dawdling.

Performance Pay

• Commissions are often paid

as a percentage of sales, in

such industries as real

estate, insurance, securities,

and retail sales.

Performance Pay• Royalties are paid to artists

who actually create a product and, like commissions, is usually a percentage of the sales price of the product. For instance, authors may receive 10% of the price of a book for each book that they sell.

Performance Pay

• Bonuses and stock

options are often paid to

executives of the

company so that they

work harder to ensure

that the company will

succeed

Performance Pay

• Bonuses are lump sum

payments which are

often paid at the end of

the year after the

employee's performance

can be assessed.

Performance Pay

• Stock options align the

interests of executives of

the company with those

of the shareholders — if

their shareholders profit,

then they will too.

Performance Pay

• Profit-sharing plans are

often used to pay a

percentage of the firm's

profits to employees so

that they work harder.

Performance Pay

• Firms may also pay

efficiency wages, which

are higher than market

wages, to attract more

productive workers.

Performance Pay

• Efficiency wages may

lower the firm's cost of

labor by hiring only

productive individuals and

lower turnover, which can

result in a more

experienced workforce.

Performance Pay

• Consequently, recruiting and

training costs are also lower.

Good employees also

require less supervision and

monitoring.

Drawbacks to Pay Incentives

• Piece rates may result in

sloppy work as workers

rush to make more

money.

Drawbacks to Pay Incentives

• Commissioned salespeople

often exaggerate claims, or

even lie, to make a sale, and

oftentimes, the product is

not in the best interest of

the customer.

Drawbacks to Pay Incentives

• Bonuses may disrupt

teamwork and cause

envy among coworkers.

Drawbacks to Pay Incentives• Because profit sharing plans

apply to all workers at a firm, less productive employees will receive the same pay incentive as more productive ones, which may cause resentment by the productive workers and anger that they are not making as much money as they could be, since how much they are ultimately paid depends on how hard the others work.