Question

What is an efficiency wage? How might payment of an above-market wage reduce shirking by employees and reduce worker turnover? How might efficiency wages contribute to downward wage inflexibility, at least for a time, when aggregate demand declines?

Short answer

The efficiency wage is set above the market equilibrium wage to incentivize the employee.

The higher wages act as an incentive that keeps the employees employed for a long time and reduces shirking or turnover.

The organizations do not want to reduce the efficiency wages when the AD decreases, creating instability.

Step-by-step solution

Efficiency wage

The efficiency wage refers to the above-market equilibrium wage paid to an employee to encourage him to work and not leave the firm. It can enhance worker productivity so much that the higher wage more than pays for itself.

Shirking and employee turnover

As the employee is paid high, he will be working in the company with greater efficiency. The cost of leaving the organization or getting removed from the organization is higher in this case. So, there is a reduction in shirking by employees. Consequently, worker turnover, which is the measurement of the number of workers who leave the organization in a specific period, reduces.

Efficiency wage and wage inflexibility

Downward wage inflexibility means the wages cannot be reduced. When the aggregate demand declines and the output shrinks, the organization does not want to cut down the efficiency wages because of the benefits it receives from it. The benefits are in the form of reduced shirking, reduced worker turnover, and reduced supervisory personnel.