Paying above-market wages may be profitable if the higher wages increase the efficiency of the firm's workers (hence the term efficiency wages). Higher wages can enhance worker productivity in several ways. For example, healthier workers tend to be more productive than less healthy workers. Also, more highly paid workers typically eat more nutritiously then less well paid workers, particularly in less developed countries, where a nutritious diet may be hard to obtain at a market wage. Firms thus have an incentive to pay high wages to maintain a healthy and productive work force.

Paying higher wages can also reduce worker turnover. Fewer workers will choose to explore other labor opportunities when a firm pays wages in excess of the prevailing market rate. Since new workers must be trained, the reduction in worker turnover can reduce the firm's training costs. By encouraging workers to stick around, the higher wages cause the experience level of the firm's workforce to rise, enhancing productivity.

Higher wages also attract a more qualified pool of job applicants. If the firm were to pay prevailing market wages, more qualified workers might choose to steer clear of the firm in favor of other companies offering higher-paying positions for which they are qualified.

Finally, higher wages may induce greater worker effort. In some firms, the costs of monitoring worker performance are quite high. Therefore, to deter shirking, a firm may decide to pay wages above the market equilibrium. The higher wages incentivize workers to work hard, since the loss of a job might mean being forced to settle for less-lucrative employment elsewhere.