Question
The Compensating Wage Differential theory predicts that,
ceteris paribus, jobs that are considered less desirable (e.g., higher risk or unpleasant conditions) will pay higher wages. This prediction holds under which key assumption about the labor market?Solution
Solution: The Compensating Wage Differential arises when workers are not indifferent between jobs and require extra pay to take on less desirable characteristics (like risk or poor working conditions). For this to work in a competitive market: · Workers must know the non-pecuniary aspects of the jobs (perfect information). · Workers must be mobile and have heterogeneous preferences for risk/conditions. · Firms must be competitive (to avoid exploitation). If workers did not know the true risk, they would not demand the differential, and the market could not equilibrate at the efficient, differential-inclusive wage.
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