Efficiency Wages

Question 1

How do Efficiency Wages cause Unemployment?

Answer 1

Keeps Real Wage above the Market Clearing Wage –> Excess Supply –> Unemployment

Question 2

What are 3 reasons for Efficiency Wages?

Answer 2

1. Improve Nutrition –> Healthier workforce
2. Absenteeism + Labour Turnover- training new workers is costly + Better Morale of workforce
3. Sociological - Good Employer-Employee relationship, ‘Gift-exchange’ Models

Question 3

What is the Selection Problem w/ Efficiency Wages?

Answer 3

Better quality workers - less willing to take a job for low pay

• So accepting low wage is a SIGNAL that worker is of Low quality or Low reservation wage
• Productivity differential > Wage Differential in L.Q workers => Reduces Profits for firm

Question 4

What 2 functions do wages serve in hidden action/shirking model?

Answer 4

Allocating Labour

Providing incentive for employee effort conditional on employment

Question 5

What happens in Equilibrium in hidden action/shirking model?

Answer 5

Firms pay Higher than Market-clearing Wage despite Unemployment
- Workers have incentive to work hard + not shirk => Higher Output + Profit for Firm

Question 6

What is Utility in the Shapiro-Stiglitz model?

Answer 6

U = w - e
w = wage
e = effort (=1 for work, =0 for shirk)

Question 7

What is the No Shirking Constraint (NSC)?

Answer 7

w ≥ e + d + [e(a + b + r) / q]
d = unemployment benefit
a = prob. of receiving job offer if Unemployed
b = prob. of being fired - not for shirking
r = worker’s rate of Time preference
q = detection rate of shirking

Question 8

What is the NSC in Full Info?

Answer 8

NSC = Ls
q = 1 => W = d + e
- Reverse L-Shaped Ls Curve

Question 9

What happens to NSC as a Increases?

Answer 9

Increased a –> Increased NSC (requires higher wage)

Question 10

What is the Vertical Intercept of NSC?

Answer 10

d + 1 + (b + r)/q - a = 0 as L = 0 at Intercept

- No Jobs –> Prob. of getting job if unemployed = 0

Question 11

What is NSC in Equilibrium?

Answer 11

a(N - L) = bL
Flow out of Unemployment pool = Flow into Unemployment pool
where L = Aggregate Employment

Question 12

Since a is Endogenous, show the relationship of a and L?

Answer 12

Rearrange: a(N - L) = bL

=> a = bL/(N - L)

Question 13

What happens to a when L increases?

Answer 13

Increased Aggregate Employment –> Higher chance of getting job if Unemployed - a Increases

Question 14

Why is Demand for Labour downward sloping?

Answer 14

Diminishing Marginal Product of Labour

Question 15

Where is Equilibrium in Hidden Action (q < 1)?

Answer 15

Eq. is at B - Ld = NSC
Employment = L*
w = w*
Involuntary Unemployment = N - L* due to Asymmetric Info.

Question 16

What is the Hidden Action problem in Employment?

Answer 16

Once hired- workers would then Shirk to save Cost of Effort

– NSC no longer satisfied

Question 17

What happens to Eq. if there is a fall in Demand for Labour?

Answer 17

Lower Ld –> Lower Employment: L* –> L’ < L*

–> Lower wage: w* –> w’ < w

Question 18

What happens to Eq. if there is an increase in Detection rate, q?

Answer 18

Higher q –> More likely to be caught –> Lower NSC –> Lower Unemployment: L* –> L’ > L
Lower wage: w* –> w’ < w

Question 19

Is a movement from B to A (Ld = Ls) a Pareto improvement?

Answer 19

No - Employers + Unemployed are better off

- Employed are worse off- Lower Wages