Shapiro Stiglitz Model

Question 1

What is the main assumption behind the positive relationship between worker effort and wages?

Answer 1

Firms have imperfect information and cannot monitor effort perfectly. Thus, they must pay a wage higher than the wage a worker would be willing to pay.

This makes losing a job costly, and induces effort.

Question 2

Theoretical set up of the model

Answer 2

Firms do not fire workers if effort is above ε.

Workers are fired with probability 0 < τ < 1 if effort is below ε.

We assume two discrete levels of effort: ε=0, and ε=ε.

Question 3

What is the optimal/efficiency wage?

Answer 3

The lowest wage (w) which induces effort ε.

Optimal wage is when workers are indifferent between shirking and not shirking.

w* = b + a/τu

Question 4

Tell me more about the efficiency wage. What affects it you filthy fucker?

Answer 4

Here you go babes. . .

So the efficiency wage depends positively upon unemployment benefits and the disutility of work. This is because a higher wage is needed to overcome the disutility.

Negatively on the unemployment rate: A higher unemployment rate means a lower efficiency wage bc its more difficult to find a job.

Negatively on monitoring efficiency and probability of τ.
higher τ lower wage.

Question 5

How would a rise in unemployment benefits shift the WS curve?

Answer 5

It was cause the curved WS curve to shift inwards, and the flat labour supply curve to shift upwards.

Question 6

How would a rise in a, or a reduction in τ affect the WS curve?

Answer 6

It would increase the slope and become steeper.