1. One criticism of the theory of compensating differentials is that workers who earn high (cash) salaries generally receive better benefits and working conditions than workers who earn low salaries. A. Does this fact necessarily disprove the theory of compensating differentials? Why or why not? B. Does the positive correlation between salaries and benefits/working conditions necessarily mean that inequality in total compensation is greater than inequality in cash salaries? Solution Answer. Theory of compensating wage differential is defined as the additional income that a worker must be offered in order to motivate him to accept a given job relative to other jobs that worker could perform. This theory provides an explaination as to why the pay differs between geographical areas. Higher pay in some areas of the country is expected where the cost of living is higher while higher pay is also necessary to compensate for a less pleasant working environment. Hence the fact that workers who earn high salaries generally receive better benefits and working conditions does not disprove the theory of compensating differentials as the reason for this might be high cost of living in the area, or they might be highly skilled workers. It is not necessary that higher pay comes only with unpleasant working condition. Thus the given criticism does not disprove the theory. Part b. Positive correlation between salaries and benefits/working conditions does not necessarily mean that inequality in total compensation is greater than inequality in cash salaries. Salary might be positively related to working conditions and benefits because of high cost of living in the area. However due to high cost of living in the area, for lower level jobs worker might be offered lower cash salary but high total benefits and better working conditions. Thus the inequality in total compensation might be lower than the inequality in cash salaries. .

1. 1. One criticism of the theory of compensating differentials is that workers who earn high (cash)
salaries generally receive better benefits and working conditions than workers who earn low
salaries.
A. Does this fact necessarily disprove the theory of compensating differentials? Why or why
not?
B. Does the positive correlation between salaries and benefits/working conditions necessarily
mean that inequality in total compensation is greater than inequality in cash salaries?
Solution
Answer. Theory of compensating wage differential is defined as the additional income that a
worker must be offered in order to motivate him to accept a given job relative to other jobs that
worker could perform. This theory provides an explaination as to why the pay differs between
geographical areas. Higher pay in some areas of the country is expected where the cost of living
is higher while higher pay is also necessary to compensate for a less pleasant working
environment.
Hence the fact that workers who earn high salaries generally receive better benefits and working
conditions does not disprove the theory of compensating differentials as the reason for this might
be high cost of living in the area, or they might be highly skilled workers. It is not necessary that
higher pay comes only with unpleasant working condition. Thus the given criticism does not
disprove the theory.
Part b. Positive correlation between salaries and benefits/working conditions does not necessarily
mean that inequality in total compensation is greater than inequality in cash salaries. Salary
might be positively related to working conditions and benefits because of high cost of living in
the area. However due to high cost of living in the area, for lower level jobs worker might be
offered lower cash salary but high total benefits and better working conditions. Thus the
inequality in total compensation might be lower than the inequality in cash salaries.