Compensating differential
Encyclopedia
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. 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.
The idea of compensating differentials has been used to analyze issues such as the risk of future unemployment, the risk of injury, the risk of unsafe sex, and the monetary value workers place on their own lives.
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. 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.
The idea of compensating differentials has been used to analyze issues such as the risk of future unemployment, the risk of injury, the risk of unsafe sex, and the monetary value workers place on their own lives.
Possible confusion with other concepts
The terms compensation differential, pay differential, and wage differential (see wage dispersionWage dispersion
Wage dispersion is an economic term which refers to the amount of variation in wages encountered in an economy.-Wage dispersion in the US and Europe:European countries have in general much less wage dispersion than the U.S. does...
or economic inequality
Economic inequality
Economic inequality comprises all disparities in the distribution of economic assets and income. The term typically refers to inequality among individuals and groups within a society, but can also refer to inequality among countries. The issue of economic inequality is related to the ideas of...
) 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. 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
Price index
A price index is a normalized average of prices for a given class of goods or services in a given region, during a given interval of time...
, economists also use the term compensating variation
Compensating variation
In economics, compensating variation is a measure of utility change introduced by John Hicks . 'Compensating variation' refers to the amount of additional money an agent would need to reach its initial utility after a change in prices, or a change in product quality, or the introduction of new...
, 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 pricingHedonic regressionIn economics, hedonic regression or hedonic demand theory is a revealed preference method of estimating demand or value. It decomposes the item being researched into its constituent characteristics, and obtains estimates of the contributory value of each characteristic...
- Search theorySearch theoryIn microeconomics, search theory studies buyers or sellers who cannot instantly find a trading partner, and must therefore search for a partner prior to transacting....