Page 584 - The Principle of Economics

598 PART NINE
THE REAL ECONOMY IN THE LONG RUN
shirking their responsibilities are fired. But not all shirkers are caught immediately because monitoring workers is costly and imperfect. A firm can respond to this problem by paying wages above the equilibrium level. High wages make workers more eager to keep their jobs and, thereby, give workers an incentive to put for- ward their best effort.
This particular type of efficiency-wage theory is similar to the old Marxist idea of the “reserve army of the unemployed.” Marx thought that employers benefited from unemployment because the threat of unemployment helped to discipline those workers who had jobs. In the worker-effort variant of efficiency-wage theory, unemployment fills a similar role. If the wage were at the level that balanced sup- ply and demand, workers would have less reason to work hard because if they were fired, they could quickly find new jobs at the same wage. Therefore, firms raise wages above the equilibrium level, causing unemployment and providing an incentive for workers not to shirk their responsibilities.
WORKER QUALITY
A fourth and final type of efficiency-wage theory emphasizes the link between wages and worker quality. When a firm hires new workers, it cannot perfectly gauge the quality of the applicants. By paying a high wage, the firm attracts a bet- ter pool of workers to apply for its jobs.
To see how this might work, consider a simple example. Waterwell Company owns one well and needs one worker to pump water from the well. Two workers, Bill and Ted, are interested in the job. Bill, a proficient worker, is willing to work for $10 per hour. Below that wage, he would rather start his own lawn-mowing business. Ted, a complete incompetent, is willing to work for anything above $2 per hour. Below that wage, he would rather sit on the beach. Economists say that Bill’s reservation wage—the lowest wage he would accept—is $10, and Ted’s reser- vation wage is $2.
What wage should the firm set? If the firm were interested in minimizing labor costs, it would set the wage at $2 per hour. At this wage, the quantity of workers supplied (one) would balance the quantity demanded. Ted would take the job, and Bill would not apply for it. Yet suppose Waterwell knows that only one of these two applicants is competent, but it does not know whether it is Bill or Ted. If the firm hires the incompetent worker, he will damage the well, causing the firm huge losses. In this case, the firm has a better strategy than paying the
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