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How firms use efficiency wages to raise employee productivity and how it explains wage stickiness in the labour market

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  1. Introduction
  2. Demonstrating and critically examining how a firm sets wages
  3. Firms in today's economic environment
  4. The economic theory of efficiency wages
  5. An explanation of wage stickiness
  6. Conclusion
  7. Bibliography

Some firms will attempt to increase their profits by improving their worker productivity by paying a wage that is above the wage paid by other competing firms. A well known example of the gains from this sort of wage setting is found in third world economies. At the market level wage, workers may not get the necessary nutrients they require in order to carry out the working day's hard labour and to maintain a healthy lifestyle. There is a vital correlation or interaction between a workers nutritional diet and their performance or productivity at the work site.

[...] Firms choosing to set wages above the equilibrium wage rate in order to maximize profits can be a very effective strategic labour policy. However, high paying organisations may not necessarily become high performing organisations because there may not be permanent wage differentials across firms. The existence of the efficiency wage model is highly dependent on the assumption that permanent wage differentials exist. This important criticism of the model is termed the bonding critique. If it is in fact true that there are no permanent wage differentials within the labour market, then workers will become indifferent between a job in a high wage industry and a job in a low wage industry. [...]

[...] These are rather plausible view held by firms who pay efficiency wages, as it is a view that is bound to hold in the real world. It has been mentioned once before in this essay that efficiency wages may not necessarily hold true in today's modern, industrialized economies. However, there is empirical evidence that efficiency can hold true in an industrialised setting and not just in a subsistence one. If this is the case, then the economic rationale behind firm's setting wages above the market clearing wage, is a sound rationale. [...]

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