This chapter covers compensating differentials, the theoretical foundation for most of the book. The key idea follows from Chapter 1's broad definition of compensation as “everything a worker likes about the job”. Jobs have many positive and negative characteristics, and workers vary in how much they value (or dislike) these characteristics. Positive job characteristics are a form of non-monetary pay, and negative characteristics diminish a worker’s effective pay. Holding other job characteristics constant, workers must be paid more to compensate them for a particular negative job characteristic and, similarly, are willing to accept less monetary pay when they enjoy a particular positive job characteristic. Workers sort across different jobs and employers based on their preferences for those job characteristics. The size of the wage differential (arising from a particular job characteristic) that occurs in the market is determined by the “marginal worker's” preferences for that job characteristic. Through a series of extensive examples, the reader is led to a thorough understanding of the marginal worker and compensating differentials, concepts which recur throughout the book.