Labour Economics Reservation wage

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Labour Economics

In this essay my aim is to provide a concise explanation to what the reservation wage is. I will firstly provide information on the term reservation wage, moving on to examples of how different people will have different reservation wages. I will convey information on each example adding possible variables which may affect their reservation wage. Then lastly I will conclude by using the information on reservation wage and different examples to conclude what I’ve learnt.

What is the reservation wage?

In simple terms this is the lowest rate at which a person will participate in the workforce or highest rate at which an individual chooses not to work. (Contemporary labour economics 4th edtition McConnell 1995)This may sound peculiar but there in fact many reasons why a person chooses not to participate in the workforce.  We are assuming the world is indeed full of rationale people. If a person receives a higher income without participating in the labour force why would he work? The person may have an inheritance, professional gambler or lack the skills to gain employment which pays more than the welfare system. There many variables which affect a reservation wage someone’s age, sex, location, health and disability

When talking about the reservation wage it is important to remember the compensating differential theory. This affects the reservation wage; this is the amount of extra income needed to motivate an individual to work in an undesirable job. Or indeed can be about an individual taking less income to work in a desirable job. A real life example two of my friends from school, two qualified electricians, same age, similar qualifications and the same amount of work experience.  One friend works on an oil rig. He works long hours, stuck in the North Sea weeks at a time and has an element to danger to his job. He works as an electrician there getting paid abnormally high wages; his surplus value would be immense.  On the other hand my other friend works as an electrician in a food manufacturing plant. He has flexible hours, works shorter days, job security he works in a thriving industry and works in his hometown with friends but does not earn as much as he would if he were to work in construction.  The tales of my two friends are the perfect example of compensating differentials affecting their reservation wage.

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How would you expect the reservation wage to be affected by a person with a history of high unemployment?

If we look Keynesian economics we’d see that wages are sticky downwards. The person is unwilling to take a lower wage due to human stubbornness, labour unions or self-interest. The consequence in the short run leads to shifts of supply and demand in the Short run. Unemployment rises and in the long run wages and prices are adjusted and eventually the economy gets back to equilibrium. This is indeed a common problem in today’s society as it is common from workers ...

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