Henry Ford and the Very Generous 5 A Day Wage Case Study

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There are a number of reasons why firms might prefer to pay a wage above the point where quantity and supply of labor are balanced. The issue is best understood by remembering that a firm is not the economy overall, so firm outcomes are differentiated from economic outcomes. Furthermore, labor mobility is substantially constrained in this world, certainly much more so than capital, so there is unlikely to be true equilibrium in the labor market. Firms know these things, so they set their strategy accordingly.

One reason a firm would pay above this equilibrium is that the firm wants to retain workers. Turnover is expensive, especially when there are high training costs. These costs must be priced into the cost of labor (Twiname, Samujh & Rae, 201). Thus, the combination of a low wage and high training costs could prove to be higher than the cost of high wage and lower training costs. This was one of Ford's issues. Training at Ford was necessary because defects are costly. Thus, the total cost of offering a higher wage might be lower. This is not a shifting of the labor curve as much as it is a replacing of the supply-demand curve for wages with the supply-demand curve for total wage + training costs.

There are other costs that can be factored in the same way. There are costs associated with recruiting workers. This is a situation that Ford faced as well, because turnover was so high at his plant. Recruitment requires people, paperwork, time and other resources. Moreover, there is a finite pool of labor within any one community. If Ford runs out of workers in Detroit faster than they can be replaced, that will cause productivity to decline.

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Thus Ford is taking into consideration the total cost of hiring workers and factoring that into the wage. By changing the understanding of the good being acquired, a company like Ford can pay a combined cost that is in line with the equilibrium. Sometimes if a market appears to be out of equilibrium, that is because there is a misunderstanding of the true nature of the market.

There is another possible reason why a firm would pay this higher wage, and the Ford experience highlights this. Detroit at the time was still a large city, but labor mobility was relatively low. Until one actually worked at Ford long enough to get a car, most people would have to move in order to get close enough to the plant to work there. There are costs associated with that. If Ford pays the equilibrium rate, consider a worker facing the option of working for Ford and working for somebody closer to home who pays the same. That worker will choose the most financially desirable option -- to stay put. The worker would not be willing to incur the cost of moving in order to take the Ford job. Ford's churn rate was very high prior to the $5 wage, and this was putting the company at risk of not being able to find enough workers in the Detroit area. As a consequence, the $5 wage was good enough to not only entice existing workers to stay, but to entice people to move to the area to work for Ford….....

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