Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.
PART 6 The Economics of Labor Markets
Chapter 19 of 36 Earnings and Discrimination
Section 10 of 16
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Most analyses of wage differences among workers are based on the equilibrium model of the labor market.
Equilibrium is the point where wage level adjusts to balance labor supply and labor demand.
However, this assumption does not always apply.
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For some workers, wages are set above the natural supply and demand equilibrium level.
There are three main reasons for above-equilibrium wages.
#1: minimum wage laws
Most workers (about 95%) are not affected by these laws because their equilibrium wages are well above the legal minimum.
But for the least skilled and productive workers, minimum wage laws raise wages above the equilibrium level.
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#2: labor unions
A union is a worker association that bargains with employers over wages and working conditions.
Unions often raise wages above the level that would prevail without a union.
This happens mainly because they can call a strike and halt or reduce production of the firm if not satisfied.
Studies show union workers earn 10 to 20 percent more than same job type nonunion workers.
Figure 1 shows an example of the effects of mandated wages.
The losses can be mitigated by the efficiency wages effect as follows.
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#3: efficiency wages
The theory of efficiency wages holds a firm can find it profitable to pay higher than equilibrium level wages because doing so increases worker productivity.
High wages may increase worker effort, reduce worker turnover, and raise the quality of job applicants.
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efficiency wages
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