Efficiency Wages

Published Dec 26, 2022

Definition of Efficiency Wages

Efficiency wages are wages that are set higher than the market rate in order to increase the productivity of workers. That means employers pay their employees more than they would in a competitive market in order to incentivize them to work harder and be more productive.

Example

To illustrate this, let’s look at a small manufacturing company. The company produces widgets and has 10 employees. In a competitive market, the company would pay its employees the market rate of USD 10.00 per hour. However, the company decided to pay its employees USD 12.00 per hour instead in the hopes of attracting better talent and encouraging employees to work harder (because they are more motivated and don’t want to lose their high-paying job). This is an example of an efficiency wage because the company is paying its employees more than the market rate with the main purpose of increasing their productivity.

Why Efficiency Wages Matter

Efficiency wages are an important concept for understanding labor markets and the behavior of employers. On the one hand, they can be used to incentivize workers to work harder and be more productive. This can lead to an increase in the company’s overall productivity, which in turn can result in higher profits.

On the other hand, efficiency wages can also be used to reduce turnover and increase loyalty among employees. This is because employees are more likely to stay with a company if they are paid more than the market rate. This can lead to a more stable workforce and fewer costs associated with hiring and training new employees.