THE THEORY OF EFFICIENCY WAGES

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THE THEORY OF EFFICIENCY WAGES.

A fourth reason economies always experience some unemployment-in addition to job search, minimum wage laws, and unions-is suggested by the theory of efficiency wages. According to this theory, 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 a surplus of labor In some ways hen employment that arises from efficiency wages is similar to the unemployment that arises from minimum-wage laws and unions. In all three cases, unemployment is the result of wages above the level that balances the quantity of labor supplied and the quantity of labor demanded. Yet there is also an important difference. Minimum-wage laws and unions prevent firms from lowering wages in the presence of a surplus of workers. Efficiency-wage theory states that such a constraint on firms is unnecessary in many cases because firms may be better off keeping wages above the equilibrium level. Why should firms want to keep wages high? This decision may seem odd at first, for wages are a large part of firms’ costs. Normally, we expect profit-maximizing firms to want to keep costs-and therefore wages-as low as possible. The novel insight of efficiency-wage theory is that paying high wages might be profitable because they might raise the-efficiency of a firm’s workers. There are several types of efficiency-wage theory. Each type suggests a different explanation for why firms may want to pay high wages. Let’s now consider four of these types.

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THE THEORY OF EFFICIENCY WAGES