What Determines Your Salary, and How You can Get a Raise

Salary is not as simple as it looks. Ever wonder why that new fresher is paid more than you? Why are you not getting a raise despite working hard for years? Understand this: Salary is not fees for your talent or effort. Two people can work equally hard, yet one earns more because their job is harder to monitor, their outside options are stronger, or their employer fears losing them. Sometimes, you may find that a worse-performing colleague may not be fired, because it is more expensive to fire an employee than to retain them.

That matters because wages shape where you live, which jobs you can refuse, and how much say you have at work. The economics of pay becomes clearer when you look inside the firm, especially in cases of firm-employee conflicts. Once you see how incentives and power work, raises stop looking unpredictable. It gives you direction, not you chasing a light at the end of a seemingly infinite tunnel. Welcome to another volume of Applied Economics, where we discuss the fascinating field of Labour Economics. 

What really determines your salary in a labour market

Your salary comes from more than factors like supply and demand (or positive assortative matching). Firms care about what you produce, but they also care about how costly you are to replace, how hard your work is to supervise, and how much profit the firm expects to keep after paying you. Endowments also play a role here. In economics, all skill sets or resources that help you earn more money.. For example, someone knowing more coding languages than you is more likely to get a raise. (because he has a better endowment/skill set.) 

That is why pay differs across jobs that look similar on the surface. A coder who can easily switch firms has more bargaining power than a retail worker with few openings nearby. A warehouse employer may pay more if turnover is high. A startup may offer lower cash pay, but add stock because it can't match large firms on wages.

Reservation Wage: The minimum salary you’ll accept

Your reservation wage is the lowest pay you will accept for a job. It quickly determines who will stay in the job market and who will not. Think of it as your personal walk-away line.

As seen in the above diagram, you won't accept any wage below Point B. You would rather be unemployed. It changes with rent, debt, savings, health insurance, family help, commute time, and risk. A student living at home may accept a lower-paying campus job because the fallback option is manageable. A parent with childcare costs usually can't. As a result, raises become easier to win when your outside options improve, because your floor rises. 

Why firms often pay more than the bare minimum

Firms do not always pay the lowest wage a worker would take. They often pay above that level because low pay can create other costs.

Hiring and training are expensive. Effort is also hard to watch in many jobs. A manager can count hours, but not always focus, care, or be accurate. So a higher wage can reduce quitting, lift morale, and make job loss painful enough that workers avoid slacking. In other words, wage-setting is often about incentives, not generosity. This is also called the No-Shirking wage curve. You may notice online memes saying “I am not paid enough to care”, or your colleagues not working hard, because they are paid just enough to do minimal work. For example, if you're paid minimum wage, why would you work harder than you have to? Hence, employers make sure you care by paying a decent wage. Just enough so you don't “shirk.” This creates a counterintuitive result: workers are sometimes paid more not because they are more productive, but because they are harder to monitor.(or because it's cheaper to pay more than setting up monitoring systems)

Shapiro-Stiglitz Model: An Elaboration on how your Wages are determined.

The Shapiro-Stiglitz model elaborates more on the idea stated in the previous paragraph. It starts with a plain idea. Effort is costly, and monitoring is imperfect. If workers can slack without much risk, some will.

So firms may offer an efficiency wage, a wage high enough that losing the job hurts. The logic of the model can be said in words: a worker compares the gain from shirking today with the cost of being caught and falling into unemployment. That cost rises when the wage is good, jobs are scarce, and it takes time to find new work.

This helps explain pay differences across roles. In hard-to-monitor jobs, like sales, remote coding, or quality control, effort is less visible. Therefore, firms may pay more to keep workers attentive. A raise in such jobs can reflect incentive design, not only kindness or merit. An alternative to paying high wages is to establish efficient monitoring systems (Cameras, a manager, piece-rate contracts and so on)

Elaborating on the No-Shirking Wage.

The no-shirking condition, or NSC, is the minimum wage that firms must pay so workers choose effort over shirking.

Better monitoring shifts the NSC downward, because firms can catch shirking more easily. Weaker monitoring shifts it upward. That is why a tight labour market often helps workers win raises. Now you know what determines your salaries? But how can you actually push for higher wages?

When workers have better exit options, employers usually need stronger pay incentives.

How Institutional and Trade Unions’ Involvement affects wages (and how you can raise yours).

Pay also relates to power. Two workers with similar productivity can earn different wages because one can bargain and the other cannot. The main question you may ask is whether Labour may not be able to control their wages or their next raise, so what's the point in reading this blog? So the answer is yes, they can control their wages. Labourers may form trade unions or elect a government that may impose their desired wages. 

Unions can raise wages by changing bargaining power. They can also improve safety, scheduling, and discipline rules. In plain terms, unions often shift part of a firm's surplus from capital to labour.

This links to the labour theory of income, the idea that earnings reflect how production gains are divided, not only personal merit. The contrast with forced labour is sharp. In voluntary labour, workers retain some exit option, even if it is weak. In forced labour, coercion removes real choice. Economically and morally, that destroys bargaining power. A trade union may refuse to work and go on strike.

The 2023 General Motors strike sets a strong precedent. United Auto Workers (UAW) workers went on strike against major automakers. After a strong financial loss, UAW workers received a strong increase in pay. It was more beneficial for the firms to accept demand than suffer even more bad publicity or loss of production power. Even billion-dollar firms go through these issues. Amazon warehouse workers unionised (rare for Amazon), pushed for better conditions and higher wages. Amazon accepted to maintain its market positioning.

To conclude,

Salary is a price, but it is also a social outcome. Productivity matters, yet so do outside options, monitoring, bargaining power, and institutions.

If you want a raise, build your leverage. Make yourself irreplaceable. Improve your outside options, document the value you create, learn the firm's constraints, and ask when replacing you would be costly. Labour economics explains your paycheck, but it also explains why income gaps persist across whole economies.

In order to be irreplaceable, one must always be different

- Coco Chanel

Want to know how to build value and make yourself irreplaceable?
Read our dedicated blog on this topic: https://ecopowered.blogspot.com/2025/07/will-ai-replace-jobs-and-how-to-keep.html The guide mentioned above is for educational purposes and purely situational. 
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