Reservation Wage

The reservation wage is the lowest wage a person is willing to accept for a given job, or the lowest pay that would persuade them to work at all. If an offer is at or above it, the person takes the job; if it is below, they keep searching or stay out of work. The idea is used in labor economics to explain who works, how long job searches last and how benefits and taxes affect the decision to take a job.

A reservation wage is personal and changes over time. It depends on a person's other income, savings, the costs of working, how much they value their time and what they believe other employers would pay. It is closely tied to voluntary unemployment and to frictional unemployment, since a higher reservation wage tends to mean a longer search.

Think of someone deciding whether to take a weekend shift at a local café. They might think: "I'd give up my Saturday for that money, but not for anything less." That private cut-off is their reservation wage. It reflects what they would otherwise do with the day, what travel costs, and whether they need the money.

When a job seeker is looking for full-time work, the same logic applies. If the pay offered is below their cut-off, they say no and keep looking. If it is above, they accept. As their savings run down, or as they learn what jobs really pay, the cut-off often moves.

• Income when not working. Unemployment benefits, welfare payments, a partner's income and savings all raise it, because they make waiting cheaper.
• Costs of working. Commuting, childcare and work clothing raise the pay needed to make a job worthwhile. Taxes and benefit withdrawal matter too: a high effective marginal tax rate on moving into work raises the gross wage needed.
• Value of time. People who place a high value on study, caring or leisure need more to give it up; the opportunity cost of working differs from person to person.
• Expectations. Beliefs about what other employers would pay, and about one's own past earnings, shape what seems acceptable.
• Job features. People may accept less pay for flexible hours, security or the chance to work from home, and demand more for night shifts or dangerous work.

The reservation wage is the core of job search models, developed in the 1970s by John McCall and others. A job seeker receives offers drawn from a range of possible wages. Accepting means giving up the chance of a better offer; waiting means losing income now. The best strategy is to set a reservation wage and accept the first offer above it. The rule can be written simply:

• $w$ is the wage offered.
• $w_R$ is the reservation wage, set where the value of taking the job equals the expected value of searching further.

For example, if a person's reservation wage is $20 an hour, they reject an offer of $18 and accept one of $21. Anything that raises the expected value of waiting, such as higher benefits or more frequent good offers, raises $w_R$. Search models were extended by Peter Diamond, Dale Mortensen and Christopher Pissarides, who shared the 2010 Nobel Memorial Prize in Economic Sciences, into theories of how unemployment and job vacancies coexist.

Reservation wages are hard to observe, so researchers ask job seekers directly. A study by Alan Krueger and Andreas Mueller, using surveys of unemployed people in New Jersey, found that reported reservation wages fell only slowly during a spell of unemployment and that people whose reservation wages were high relative to their previous pay tended to stay unemployed longer. Other studies link more generous or longer benefits to somewhat higher reservation wages and longer searches, though estimates vary.

The concept shapes several policy debates:

• Benefit design. Job-search requirements and welfare-to-work programs aim to stop reservation wages from staying above realistic offers.
• Making work pay. In-work tax credits and a negative income tax raise take-home pay so more offers clear people's reservation wages.
• Minimum wages. A minimum wage above many people's reservation wage can draw more of them into the labor force, though critics argue it may reduce the number of jobs offered.
• Basic income. Critics of universal basic income argue it would raise reservation wages and reduce work; supporters say it would let people refuse exploitative jobs. Trials so far have generally found small effects on employment.

When reservation wages are high across a population, more people are counted as unemployed or economically inactive, which can raise the natural rate of unemployment.

• Nobel Prize: The Prize in Economic Sciences 2010