6  Efficiency wages

In a basic model of labour market equilibrium, the wage adjusts so that there is neither excess demand nor supply. This is the “market clearing” level.

The idea behind efficiency wages is that firms might pay wages above the market clearing level to increase employee productivity. Two of the traditional economic explanations are as follows:

If all firms in a market pay efficiency wages, there may be involuntary unemployment at equilibrium. Unemployed workers cannot credibly signal that they will work for lower wages as they may then shirk.