In labor economics, an efficiency wage is a wage paid in excess of the market-clearing wage to increase the labor productivity of workers. Specifically, it points to the incentive for managers to pay their employees more than the market-clearing wage to increase their productivity or to reduce the costs associated with employee turnover.

Theories of efficiency wages explain the existence of involuntary unemployment in economies outside of recessions, providing for a natural rate of unemployment above zero. Because workers are paid more than the equilibrium wage, workers may experience periods of unemployment in which workers compete for a limited supply of well-paying jobs.

There are several reasons why managers may pay efficiency wages:

The model of efficiency wages, largely based on shirking, developed by Carl Shapiro and Joseph E. Stiglitz has been particularly influential.^{[citation needed]}

A theory in which employers voluntarily pay employees above the market equilibrium level to increase worker productivity. The shirking model begins with the fact that complete contracts rarely (or never) exist in the real world. This implies that both parties to the contract have some discretion, but frequently, due to monitoring problems, the employee's side of the bargain is subject to the most discretion. Methods such as piece rates are often impracticable because monitoring is too costly or inaccurate; or they may be based on measures too imperfectly verifiable by workers, creating a moral hazard problem on the employer's side. Thus, paying a wage in excess of market-clearing may provide employees with cost-effective incentives to work rather than shirk.

In the Shapiro and Stiglitz model, workers either work or shirk, and if they shirk they have a certain probability of being caught, with the penalty of being fired. Equilibrium then entails unemployment, because to create an opportunity cost to shirking, firms try to raise their wages above the market average (so that sacked workers face a probabilistic loss). But since all firms do this, the market wage itself is pushed up, and the result is that wages are raised above market-clearing, creating involuntary unemployment. This creates a low, or no income alternative, which makes job loss costly and serves as a worker discipline device. Unemployed workers cannot bid for jobs by offering to work at lower wages since, if hired, it would be in the worker's interest to shirk on the job, and he has no credible way of promising not to do so. Shapiro and Stiglitz point out that their assumption that workers are identical (e.g. there is no stigma to having been fired) is a strong one – in practice, reputation can work as an additional disciplining device. Conversely, higher wages and unemployment increase the cost of finding a new job after being laid off. So in the shirking model, higher wages are also a monetary incentive.

Shapiro-Stiglitz's model holds that unemployment threatens workers, and the stronger the danger, the more willing workers are to work through correct behavior. This view illustrates the endogenous decision-making of workers in the labor market; that is, workers will be more inclined to work hard when faced with the threat of unemployment to avoid the risk of unemployment. In the labor market, many factors influence workers' behavior and supply. Among them, the threat of unemployment is an essential factor affecting workers' behavior and supply. When workers are at risk of losing their jobs, they tend to increase their productivity and efficiency by working harder, thus improving their chances of employment. This endogenous decision of behavior and supply can somewhat alleviate the unemployment problem in the labor market.

The shirking model does not predict that the bulk of the unemployed at any one time are those fired for shirking, because if the threat associated with being fired is effective, little or no shirking and sacking will occur. Instead, the unemployed will consist of a rotating pool of individuals who have quit for personal reasons, are new entrants to the labour market, or have been laid off for other reasons. Pareto optimality, with costly monitoring, will entail some unemployment since unemployment plays a socially valuable role in creating work incentives. But the equilibrium unemployment rate will not be Pareto optimal since firms do not consider the social cost of the unemployment they helped to create.