2022
LABOUR ECONOMICS (ECS2604)
ASSIGNMENT 2 SOLUTIONS SEMESTER
1 2022
, Question 1
Use the efficiency wage hypothesis to discuss the statement: “under certain
circumstances a wage increase could lead to increase in productivity”. (10)
Efficiency wage hypothesis posits that under certain circumstances a wage increase could lead to
increase in productivity. What is important is not whether productivity increases, but whether it
increases by more than the wage increase, i.e. whether the productivity improvement fully
compensates for the labour cost increase. If this does indeed happen, it might be more efficient
for the employer to pay higher wages, as this might reduce the unit labour cost.
There are various reasons why this might be the outcome. An employer must pay its workers
high enough so that workers are incentivized to be productive and that highly skilled workers do
not quit. Higher wages might enable (or induce) the employer to recruit employees more
carefully. This increases the chances of recruiting fit-for-purpose employees and hence
productivity increases. A higher wage might make employers more willing to invest in their
workers. This makes the employees even more productive as the employer is willing to train and
retrain its employees.
Workers’ morale might improve due to their higher wages, and their absenteeism might be lower
because their opportunity cost of not working is higher. This also improves effort that the worker
exerts and productivity increases. Furthermore, workers’ nutritional and health levels might
improve, positively affecting their physical vigour and mental alertness of workers.
Workers might, at least in the short term, be motivated by the higher wages to improve their
productive effort. They might even do so over the long term if they fear being dismissed from a
well-paying job. Labour productivity might also increase as a result of wage increases if the
employer attempts to reduce the wage bill by becoming more capital intensive.
LABOUR ECONOMICS (ECS2604)
ASSIGNMENT 2 SOLUTIONS SEMESTER
1 2022
, Question 1
Use the efficiency wage hypothesis to discuss the statement: “under certain
circumstances a wage increase could lead to increase in productivity”. (10)
Efficiency wage hypothesis posits that under certain circumstances a wage increase could lead to
increase in productivity. What is important is not whether productivity increases, but whether it
increases by more than the wage increase, i.e. whether the productivity improvement fully
compensates for the labour cost increase. If this does indeed happen, it might be more efficient
for the employer to pay higher wages, as this might reduce the unit labour cost.
There are various reasons why this might be the outcome. An employer must pay its workers
high enough so that workers are incentivized to be productive and that highly skilled workers do
not quit. Higher wages might enable (or induce) the employer to recruit employees more
carefully. This increases the chances of recruiting fit-for-purpose employees and hence
productivity increases. A higher wage might make employers more willing to invest in their
workers. This makes the employees even more productive as the employer is willing to train and
retrain its employees.
Workers’ morale might improve due to their higher wages, and their absenteeism might be lower
because their opportunity cost of not working is higher. This also improves effort that the worker
exerts and productivity increases. Furthermore, workers’ nutritional and health levels might
improve, positively affecting their physical vigour and mental alertness of workers.
Workers might, at least in the short term, be motivated by the higher wages to improve their
productive effort. They might even do so over the long term if they fear being dismissed from a
well-paying job. Labour productivity might also increase as a result of wage increases if the
employer attempts to reduce the wage bill by becoming more capital intensive.
