Efficiency wage
| Efficiency wage |
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Efficiency wages are wages that are higher than the equilibrium market rate in order to improve employee performance. This theory suggests that an employer can increase the efficiency of a workforce by increasing wages as employees will be motivated to work harder in order to retain their job. Increasing wages can also reduce turnover and provide incentives for employees to work harder. Efficiency wages can be beneficial for both employers and employees as it increases productivity and can improve job satisfaction.
The four main components of efficiency wages are:
- Higher wages: Higher wages are used to motivate employees to work harder and give them an incentive to stay with the company. This can increase productivity and reduce turnover.
- Job security: Job security is important in order to motivate employees to work harder. Providing job security can ensure that employees will remain loyal to the company and will be less likely to leave for higher wages elsewhere.
- Monitoring: Employers can use monitoring to ensure that employees are putting in the necessary effort and are being productive. This can include surveillance, performance reviews or other methods.
- Reward system: Employers can use a reward system to reward employees for their hard work and to encourage them to continue to work hard. This can include bonuses, promotions or other forms of recognition.
Example of Efficiency wage
An example of an efficiency wage is if an employer raises a worker's wage from $10 to $12 per hour. This wage increase can motivate the employee to work harder and be more productive, as they will be more likely to retain their job and gain more money, leading to higher efficiency. The wage increase can also lead to lower turnover, as the employee is less likely to look for another job due to the higher wage. At the same time, the employer can benefit from higher productivity and less turnover, leading to increased profits.
Overall, efficiency wages can be beneficial for both employers and employees, as they can increase productivity and reduce turnover. They can also lead to higher job satisfaction, as employees will be motivated to work harder and stay with the company.
Formula of Efficiency wage
The formula for efficiency wages is as follows:
Where W* is the efficiency wage, μ is the probability of job loss, w is the market wage rate and s is the difference between the efficiency wage and the market wage rate.
When to use Efficiency wage
Efficiency wages can be beneficial for employers and employees alike, but there are certain conditions that must be met in order for them to be effective. The following conditions should be taken into consideration when deciding whether or not to use efficiency wages:
- The employer must have the resources to pay higher wages.
- Employees must be willing to work harder in exchange for higher wages.
- The job must be monitored in order to ensure that employees are working hard.
- The employer must have a reward system in place to provide incentives and recognition for hard work.
- The efficiency wage should be set at a level that is higher than the equilibrium market rate.
Types of Efficiency wage
- Market-based efficiency wages: This type of efficiency wage is based on the market rate of pay and is determined by the supply and demand of the labor market.
- Social efficiency wages: This type of efficiency wage is based on the values of an organization and is designed to reflect the company’s beliefs and values.
- Internal efficiency wages: This type of efficiency wage is based on the internal policies of an organization and is designed to promote productivity and loyalty.
Advantages of Efficiency wage
There are several advantages to using efficiency wages, including:
- Increased productivity: Higher wages can lead to increased productivity as employees are more motivated to work hard.
- Lower turnover: Higher wages and job security can reduce turnover as employees are less likely to leave for higher wages elsewhere.
- Reduced costs: By reducing turnover, employers can save money on recruiting and training costs.
- Improved morale: Providing job security and a reward system can improve morale and job satisfaction.
Limitations of Efficiency wage
Efficiency wages do have some limitations. For example, they can be costly for employers as they require higher wages than the equilibrium wage rate. This can be difficult for employers to absorb, particularly during times of economic recession. Also, some employees may not be motivated by higher wages and may still be unproductive. Finally, a higher wage rate can lead to inflation, which can be difficult to control.
- Piece rate system: Piece rate system is a system where workers are paid per unit of output instead of a fixed salary. This system can encourage employees to work harder, as they will receive more money for more work.
- Merit pay: Merit pay is a system in which employees are rewarded for good performance with higher wages or bonuses. This system can encourage employees to work harder in order to receive higher wages.
- Profit sharing: Profit sharing is a system in which employees are given a share of the profits that the company earns. This system can motivate employees to work harder in order to increase the company's profits and their own wages.
In conclusion, efficiency wages are a way of increasing employee performance and productivity by providing higher wages, job security, monitoring and a reward system. Other approaches such as the piece rate system, merit pay and profit sharing can also be used to motivate employees and increase productivity.
Suggested literature
- Yellen, J. (1995). Efficiency wage models of unemployment (pp. 280-289). Macmillan Education UK.
- Katz, L. F. (1986). Efficiency wage theories: A partial evaluation. NBER macroeconomics annual, 1, 235-276.
