In labor economics, the efficiency wage hypothesis argues that wages, at least in some markets, are determined by more than supply and demand. Specifically, it points to the incentive for managers to pay their employees more than the market-clearing wage in order to increase their productivity or efficiency. This increased labor productivity pays for the higher wages.
Because workers are paid more than the equilibrium wage, there will be unemployment. Efficiency wages are therefore a market failure explanation of unemployment – in contrast to theories which emphasize government intervention (such as minimum wages).
The idea of efficiency wages was expressed as early as 1920 by Alfred Marshall. Efficiency wage theory has reemerged several times and is especially important in new Keynesian economics.
Read more about Efficiency Wage: Overview, Shirking, Labor Turnover, Adverse Selection, Empirical Literature
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