What does a compensating differential refer to?

A compensating differential refers to the wage differences that arise to offset variations in job characteristics, primarily related to the working conditions of different jobs. For example, if one job is more hazardous, requires longer hours, or has less desirable working hours compared to another job, the wage for the more unpleasant job must be higher to attract workers. This additional pay serves as a compensation for the less favorable aspects associated with that job.

In this context, workers evaluate the entire package of a job, including both the wage and any associated job risks or disadvantages. Thus, the differential is a reflection of how wages adjust to maintain equilibrium in labor markets by compensating for less attractive job features.