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Lecture II: Constructing a theory of equilibrium unemployment

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Lecture II: Constructing a theory of equilibrium unemployment

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### Lecture II: Constructing a theory of equilibrium unemployment

Microeconomic foundations of the wage curve

How are wages set?

- Wages can be thought of as the sum of three terms:
- A compensation for the disutility of labor
- An outside option which determines what the worker would get outsidr the employment relationship (alternative wage = OC of labor)
- A rent which tells us how much he can grab beyond that

When is unemployment involuntary?

- If the employed are better-off than the unemployed, the latter would prefer to be employed
- Therefore, involuntary unemployment rent = 0
- Does that mean we are at the Walrasian equilibrium?

What is a Walrasian equilibrium?

- WE holds if outside option = flow of utility corresponding to a zero wage
- But Unemployment Benefits and Welfare Minima can raise OO above that level
- Unemployment is then voluntary but above the walrasian level

Do we need rents in the model?

- Assume no rent
- For h(u) to be downward sloping, unemployment must negatively affect the outside option
- This cannot be true if the employed are no better-off than the unemployed
- We thus have a flat h(u) curve and are back to the wage floor model

Three classes of models:

- Collective bargaining models rents come from the union’s monopoly on jobs
- Individual barganing models rents come from turnover costs
- Efficiency wage models rents come from informational issues + incomplete contracting

Collective bargaining models

- There are three of them:
- Monopoly Union
- Efficient Bargaining
- Right-to-Manage

What is going on?

- The union maximizes the total expected income of members
- It takes the LD curve as given
- Wages = markup on OC of labor
- Markup inversely related to elasticity
- OC of labor reflects job finding prospects goes down with u
- If UB indexed on wages, natural rate only depends on replacement ratio and elasticity

Membership effects

- Note that union membership N has no impact on the outcome
- We can get membershif effects by introducing nonlinearities
- Example: unions maximize the median members’ expected income
- His employment probability is nonlinear in L/N

Comments:

- If elasticity of φ falls, then lower membership => higher wages and more unemployment
- If membership depends on past employment => persistence mechanism
- Membership rules matter (encompassing unions vs. Guilds)

Comments:

- Employment is determined at the privately efficient level from the match’s point of view
- Absent institutional rigidities, employment would be at its walrasian level
- Wage bargaining only affects the way the surplus is split wages are a pure transfer, the true allocative price is the OCL

Comments

- Generalization of monopoly union model
- Generates suboptimal employment
- The rent now depends on the workers’ bargaining power in addition to the elasticity of labor demand

Individual bargaining

- In collective models, the firms cannot hire workers competitively at the margin
- Nor can other firms in the same sector do so
- Under individual bargaining, the firm could drive the surplus of the match to zero by simply hiring more people
- Turnover costs are needed to create a positive surplus

The dynamic insider/outsider model

- A representative firm can hire as much as it wants from the pool of unemployed
- Once hired, people negotiate their wage
- The firms incurs a cost F upon separation due to disagreement

The hold-up problem:

- The intertemporal rent is fixed
- It goes up with the turnover cost
- It goes up with the worker’s bargaining power
- The turnover cost is a specific investment which can be appropriated by the incumbent worker
- F could equivalently be a hiring cost

Wage pressure goes up with

- Turnover costs
- Insider bargaining power
- Unemployment benefits
- Turnover
- Real interest rates

The shirking model

- Employee effort e imperfectly observable (flow probability q)
- Penalty upon shirking limited to dismissal
- In equilibrium, employees must be paid rents
- Otherwise, no penalty from dismissal: a job is found instantaneously
- Thus, unemployment duration acts as a discipline device

Comments:

- The model is equivalent to I-O model
- Just replace rent by e/q
- Rent now depends on effort levels and on the monitoring probability
- Effects of s and r are the same

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