Compensating differential

Compensating differential is a term used in labor economics to analyze the relation between the wage rate and the unpleasantness, risk, or other undesirable attributes of a particular job. A compensating differential, which is also called a compensating wage differential or an equalizing difference, is defined as the additional amount of income that a given worker must be offered in order to motivate them to accept a given undesirable job, relative to other jobs that worker could perform.^[1][2] One can also speak of the compensating differential for an especially desirable job, or one that provides special benefits, but in this case the differential would be negative: that is, a given worker would be willing to accept a lower wage for an especially desirable job, relative to other jobs.^[3]

The idea of compensating differentials has been used to analyze issues such as the risk of future unemployment,^[4] the risk of injury,^[5] the risk of unsafe sex,^[6] and the monetary value workers place on their own lives.^[7]

Possible confusion with other concepts

The terms compensation differential, pay differential, and wage differential (see wage dispersion or economic inequality) are also used in economics, but normally have a different meaning. They simply refer to differences in total pay (or the wage rate) in any context.^[8] So a 'compensation differential' can be explained by many factors, such as differences in the skills of the workers in those jobs, the country or geographical area in which those jobs are performed, or the characteristics of the jobs themselves. A 'compensating differential', in contrast, refers only to differences in pay due to differences in the jobs themselves, for a given worker (or for two identical workers).

In the theory of price indices, economists also use the term compensating variation, which is yet another unrelated concept. A 'compensating variation' is the change in wealth required to leave a consumer's well-being unchanged when prices change.

See also

• Wages
• Labor economics
• Hedonic pricing
• Search theory

References

1. ^ Kaufman, Bruce E.; Hotchkiss, Julie L. (2005). "Education, Training, and Earnings Differentials: The Theory of Human Capital". The economics of labor markets (5th ed.). Harcourt College Publishers. ISBN 0324288794. 
2. ^ Rosen, Sherwin (1986). "The theory of equalizing differences". In Ashenfelter, Orley; Layard, Richard. The Handbook of Labor Economics. 1. New York: Elsevier. pp. 641–692. ISBN 0444878564. 
3. ^ Miller, Richard D., Jr. (2004). "Estimating the compensating differential for employer-provided health insurance". International Journal of Health Care Finance and Economics 4 (1): 27–41. doi:10.1023/B:IHFE.0000019259.74756.65. 
4. ^ Averett, Susan; Bodenhorn, Howard; Staisiunas, Justas (2003). "Unemployment risk and compensating differential in late-nineteenth century New Jersey manufacturing". National Bureau of Economic Research Working Paper 9977 (Cambridge, Massachusetts). 
5. ^ Biddle, Jeff E.; Zarkin, Gary A. (1988). "Worker preference and market compensation for job risk". Review of Economics and Statistics 70 (4): 660–667. JSTOR 1935830. 
6. ^ Rao, Vijayendra; Gupta, Indrani; Lokshin, Michael; Jana, Smarajit (2003). "Sex workers and the cost of safe sex: the compensating differential for condom use among Calcutta prostitutes". Journal of Development Economics 71 (2): 585–603. doi:10.1016/S0304-3878(03)00025-7. 
7. ^ Thaler, Richard; Rosen, Sherwin (1975). "The value of saving a life: evidence from the labor market". In Terleckyj, Nestor E.. Household production and consumption. New York: National Bureau of Economic Research. ISBN 0870145150. 
8. ^ Bender, Keith A. (1998). "The central government-private sector wage differential". Journal of Economic Surveys 12 (2): 177–220. doi:10.1111/1467-6419.00052.