Problem #4: Risk and earnings
Consider an economy with many different types of jobs and workers. A researcher has
constructed a data set that records the earnings of a worker in each type of job as well as
the risk of injury. The researcher finds that a 1% increase in injury risk is associated with
a 0.5% increase in earnings. Yet, when the researcher asks any worker in the economy if he
or she would be willing to pay 0.5% of his or her earnings in return for a 1% reduction in
risk, the offer is always refused. Similarly, if offered a 0.5% increase in earnings in return for
a 1% increase in risk, again the offer is always refused. Is this behavior consistent with the
theory of compensating differentials? Explain.