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Compensating differences

| Saturday, Aug. 6, 2016, 9:00 p.m.

What economists call an ability to make “compensating differences” is a valuable tool in everyone's arsenal. If people are prohibited from doing so, they are always worse off.

Jimmy Soul's 1963 hit song, “If You Wanna Be Happy,” explained the concept of compensating differences. The lyrics went: “If you want to be happy for the rest of your life, never make a pretty woman your wife. So from my personal point of view, get an ugly girl to marry you.”

His point was that an ugly woman would treat you better.

It goes the other way around, too. I've presented people with the following scenario: Suppose you saw a fat, ugly, cigar-smoking old man married to a beautiful young woman. What kind of prediction would you make about the man's income? Everybody I've asked guesses that he would have a high income. The fat, ugly, cigar-smoking old man would essentially be telling the beautiful young woman, “I can't compete for your hand the same way a guy like Williams can, so I'm going to offset my handicap by offering you a higher price.”

Suppose they enacted a law saying beautiful women cannot treat fat, ugly, cigar-smoking old men any differently than they treat handsome men. What would happen to the probability of a fat, ugly, cigar-smoking old man marrying a beautiful woman? Most people would guess that it would go to zilch.

There are many real-world examples of compensating differences. Attending physicians receive hourly pay that ranges from $80 and $157. Residents earn about $34 an hour. What do you think would happen to a hospital's willingness to hire a resident if there were a minimum hourly wage for interns of, say, $60, $70 or $100? There would be reduced learning opportunities for doctors in training.

You might wonder how poor, discriminated-against people managed to seize the land-use control of neighborhoods. They did it through the market mechanism. For example, there might have been a racially discriminatory landlord who rented his three-story brownstone to a white family for $100 a month. Maybe six black families approached the owner with the proposition that if he cut the building into six apartments, each family would pay him $50 a month. That would mean he could earn $300 a month renting to blacks rather than $100 renting to a white family.

Compensating differences abound. Even though chuck steak is less preferred, it outsells filet mignon. Less-preferred Toyotas compete with Mercedes-Benzes. Costume jewelry competes with fine jewelry. You might say, “Williams, people are not cars, steaks or jewelry!” But they respond to the same economic laws as cars, steaks and jewelry.

Walter Williams is a professor of economics at George Mason University.

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