15.5 The Theory of Efficiency Wages

The efficiency wage is a wage that is above the equilibrium wage that firms voluntarily choose to pay in order to increase their profits [21].

A firm would choose to pay a higher wage than the equilibrium because [21]:

• Paying workers a wage above the market level motivates them, and therefore goes directly to the company’s bottom lines and they get a higher quality, more productive worker.
• A happy, healthy worker is more productive. Workers who can afford better health care, better food, are going to come to work rested, healthy, and productive. Another idea is that if workers are paid better, the workers will take better care of themselves, and therefore the workers will become more productive.
• At higher wages a company is able to attract the more productive, talented and skilled workers.
• Paying a high wage reduces employee turnover. If the workers get a good deal and are happy, they will not leave, that lowers the overall cost of managing labor.

Example: When Henry Ford paid a higher wage, he was the most desirable job in town; and therefore workers who were under his direction were highly motivated.

^{Henry Ford’s Efficiency Wages [22]}