WAGE

Wage

Wage

Introduction

The effciency wage theory developed by Akerlof (1982) assumes observability of effort and the ability of firm and worker to commit on their effort/wage decisions. We show that, from a game theoretical point of view, we have to understand the firm/worker relationship as a repeated Prisoner's dilemma. Therefore, cooperation is per se not a (subgame perfect) Nash equilibrium and hence the Akerlof (1982) theory is based upon an implicit assumption of cooperation, which can not be implemented w.l.o.g.. In addition, we find that this approach is a special case of the Shapiro and Stiglitz (2004) approach and hence unify the two approaches. This paper discusses in what ways firm's view of the wage and the worker's view of the wage differ.

Discussion

In order to explain equilibrium unemployment, nobel laureate George A. Akerlof developed the fair wage theory based on the sociological partial gift exchange approach (see Akerlof (1982)). This theory explains equilibrium unemployment by the fact that the wage is above the market clearing wage. The reason for this non- neoclassical phenomenon is the fact that firms tend to pay a higher wage in order to ensure that workers provide a desired amount of effort(Burgess, Simon , David, 2007). In contrast to Akerlof's idea, Shapiro and Stiglitz (2004) suggested a different type of effciency wage model.

While in Akerlof's model effort is observable and measurable, Shapiro and Stiglitz assume that effort is not observable. Consistently, a worker has an incentive to shirk, viz. the worker might not provide effort. Under equilibrium full employment, this would urge the firm to pay a wage that is above the market clearing wage, in order to create some punishment for shirking(Burgess, Simon , David, 2007). As a direct consequence, equilibrium full employment is not feasible, since the higher wage will decrease labor demand and cause (equilibrium) unemployment. We see that both theories work along the same dimension, namely increasing the wage above the market clearing wage, but with different causes. However, there are several challenges afficted with Akerlof's idea in a dynamic context.

Especially, the assumption of commitable effort is cru- cial. Akerlof (1982) states that "Since output is easily observable, it is at least a bit surprising ... that workers are not paid wages proportional to their outputs." From our point of view, the observation of each worker is hardly imaginable due to monitoring costs and the possible negative psychological effects on the workers motivation. Consistently, and because the firm/worker pair sets the wage/effort at the beginning of the period - since the firm maximizes profits and defines its plan at the beginning of every period, while the household maximizes utility at the beginning of the period -, the proportional wage is only a hypothetical construct. Let us consider a dynamic version based upon the Akerlof approach. The underlying decision process can be deconstructed in the following steps.

A firm-worker match exists or is created. Firm's solve their optimization problem. Firm's set the optimal wage. Worker's receive the wage offer and set their ...