Efficiency Wage[]

Efficiency wage is a theory in attempt to explain the persistance of Unemployment, or excess supply of labor, in the economy. In general, efficiency wages are a response to asymmetric information about employees, combating both moral hazard and adverse selection. Other (though not neccessarily contradictory) way to understand efficiency wages are to view the employee that works hard when paid well and works little when paid less as two fundamentally different workers.

Moral Hazard[]

Because policing their employees all the time is not cost effective, paying them about the "market clearing" wage creates unemployment (fewer firms are willing to hire, more people are willing to work). Thus there exists the threat of being fired and not being able to find work right away. In turn, workers work harder than they normally would; shirking is reduced.

Adverse Selection[]

Because it is costly the "best" employee for a potential job, some firms may offer a higher wage which attracts better workers, increasing the percentage of good workers and, therefore, increasing the chance one of these good workers will be offered the position.

Different Workers[]

Closely connected to moral hazard, efficiency wages may exist to bestow good morale or a healthier lifestyle on its employees, increasing their efficiency. Well paid workers are also less likely to quit so turnover decreases, decreasing the costs of hiring and retraining. Note that this interpretation is different from moral hazard in the same way sticks are different from carrots. The moral hazard reasoning operates on the employee's fear of being unemployed while the different workers theory focuses on positive reinforcement.


  • Wikipedia entry
  • George A. Akerlof and Janet Yellen (1986), 'Efficiency Wage Models of the Labor Market', Cambridge: Cambridge University Press (ISBN 0 521 31284 1)
  • Akerlof, George A. (1982), “Labor Contracts as Partial Gift Exchange,” Quarterly Journal of Economics, 97, p543-69
  • Akerlof and Yellen (1990), “The Fair Wage-Effort Hypothesis and Unemployment,” Quarterly Journal of Economics, 105 (2), (May 1990), p255-283