Efficiency Wage Theory


Definition of Efficiency Wage Theory / Hypothesis

The idea of the efficiency wage theory is that it may benefit firms to pay workers a wage higher than their marginal revenue product.

The argument is that paying workers a higher wage may lead to increased productivity from the worker. If a worker gets a relatively higher wage, he may feel more loyal and devoted to the company. With a higher wage, he may also fear being made unemployed and so will work harder to make sure he keeps his job. Therefore, although the firm pays more, they get more productivity from their workers.

It could also be the case that a monopsonist pays less than the MRP leading to demotivated workers; in this case, raising wage could lead to higher productivity.

In practise, many factors determine worker morale and productivity, wages are just one of them. Often other factors are more important such as work conditions, management, e.t.c.

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