Introduction
The Efficiency Wage Model suggests that firms may pay wages above the equilibrium level to increase productivity, reduce turnover, and improve worker morale.
Higher wages can incentivize workers to put in more effort, reduce shirking, and lower the costs of monitoring. This model can also explain involuntary unemployment, where higher wages lead to excess labor supply because firms hire fewer workers at above-market wages.
Strengths:
- Explains wage rigidity and unemployment: Higher wages may prevent firms from lowering wages in downturns, leading to unemployment.
- Reduces turnover: Paying higher wages can help retain experienced employees and reduce training costs.
- Increases effort: Higher wages may motivate employees to work harder, improving productivity.
Limitations:
- Unemployment: Higher wages can lead to excess supply of labor, causing unemployment.
- Increased costs: Paying above-market wages raises costs for firms, which may affect profitability.
- Overemphasis on monetary incentives: The model focuses mainly on wages, ignoring other factors like job satisfaction and work conditions.
In conclusion, the Efficiency Wage Model helps explain how wages above the market rate can improve productivity, but it also has drawbacks, such as potential unemployment and increased firm costs.
