Involuntary unemployment appears to be a persistent feature of many modem labor markets. The presence of such unemployment raises the question of why wages do not fall to clear labor markets. In this paper we show how the information structure of employer-employee relationships, in particular the inability of employers to costlessly observe workers' on-the-job effort, can explain involuntary unemployment' as an equilibrium phenomenon. Indeed, we show that imperfect monitoring necessitates unemployment in equilibrium. The intuition behind our result is simple. Under the conventional competitive paradigm, in which all workers receive the market wage and there is no unemployment, the worst that can happen to a worker who shirks on the job is that he is fired. Since he can immediately be rehired, however, he pays no penalty for his misdemeanor. With imperfect monitoring and full employment, therefore, workers will choose to shirk. To induce its workers not to shirk, the firm attempts to pay more than the "going wage"; then, if a worker is caught shirking and is fired, he will pay a penalty. If it pays one firm to raise its wage, however, it will pay all firms to raise their wages. When they all raise their wages, the incentive not to shirk again disappears. But as all firms raise their wages, their demand for labor decreases, and unemployment results. With unemployment, even if all firms pay the same wages, a worker has an incentive not to shirk. For, if he is fired, an individual will not immediately obtain another job. The equilibrium unemployment rate must be sufficiently large that it pays workers to work rather than to take the risk of being caught shirking. The idea that the threat of firing a worker is a method of discipline is not novel. Guillermo Calvo (1981) studied a static model which involves equilibrium unemployment.2 No previous studies have treated general market equilibrium with dynamics, however, or studied the welfare properties of such unemployment equilibria. One key contribution of this paper is that the punishment associated with being fired is endogenous, as it depends on the equilibrium rate of unemployment. Our analysis thus goes beyond studies of information and incentives within organizations (such as Armen Alchian and Harold Demsetz, 1972, and the more recent and growing literature on worker-firm relations as a principal-agent problem) to inquire about the equilibrium conditions in markets with these informational features. The paper closest in spirit to ours is Steven Salop (1979) in which firms reduce turnover costs when they raise wages; here the savings from higher wages are on monitoring costs (or, at the same level of monitoring, from increased output due to increased effort). As in the Salop paper, the unemployment in this paper is definitely involuntary, and not of the standard search theory type (Peter Diamond, 1981, for example). Workers have perfect information about all job opportunities in our model, and unemployed workers strictly prefer to work at wages less than the prevailing market wage (rather than to remain unemployed); there are no vacancies. *Woodrow Wilson School of Public and International Affairs, and Department of Economics, respectively, Princeton University, Princeton, NJ 08540. We thank Peter Diamond, Gene Grossman, Ed Lazear, Steve Salop, and Mike Veall for helpful comments. Financial support from the National Science Foundation is appreciated. 'By involuntary unemployment we mean a situation where an unemployed worker is willing to work for less than the wage received by an equally skilled employed worker, yet no job offers are forthcoming. 2In his 1979 paper, Calvo surveyed a variety of models of unemployment, including his hierarchical firm model (also with Stanislaw Wellisz, 1979). There are a number of important differences between that work and this paper, including the specification of the monitoring technology.

Efficiency Wage Models of the Labor Market: Equilibrium Unemployment as a Worker Discipline Device

This paper develops techniques for empirically analyzing demand and supply in differentiated products markets and then applies these techniques to analyze equilibrium in the U.S. automobile industry. Our primary goal is to present a framework which enables one to obtain estimates of demand and cost parameters for a class of oligopolistic differentiated products markets. These estimates can be obtained using only widely available product-level and aggregate consumer-level data, and they are consistent with a structural model of equilibrium in an oligopolistic industry. When we apply the tech- niques developed here to the U.S. automobile market, we obtain cost and demand parameters for (essentially) all models marketed over a twenty year period.

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Automobile prices in market equilibrium

Economic theorists traditionally banish discussions of information to footnotes. Serious consideration of costs of communication, imperfect knowledge, and the like would, it is believed, complicate without informing. This paper, which analyzes competitive markets in which the characteristics of the commodities exchanged are not fully known to at least one of the parties to the transaction, suggests that this comforting myth is false. Some of the most important conclusions of economic theory are not robust to considerations of imperfect information.

/pdf/equilibrium-in-competitive-insurance-markets-an-essay-on-the-zfnjmlwysx.pdf

Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information

The author systematically examines one of the important issues of information — establishing the market price. He introduces the concept of «search» — where a buyer wanting to get a better price, is forced to question sellers. The article deals with various aspects of finding the necessary information.

Economics of Information

I NCENTIVES ARE the essence of economics. Despite many wide-ranging claims about their supposed importance, there has been little empirical assessment of incentive provision for workers. The purpose of this paper is to critically overview existing work on the provision of incentives. Since the interests of workers and their employers are not always aligned, a large theoretical literature has emphasized how firms design compensation contracts to induce employees to operate in the firm's interest. This literature has reached into many areas of compensation and has pointed to a multitude of different mechanisms that can be used to induce workers to act in the interests of their employers. These include piece rates, options, discretionary bonuses, promotions, profit sharing, efficiency wages, deferred compensation, and so on. My objective here is to evaluate this literature in the light of a growing empirical literature on compensation. Where possible, I will address the literature from two perspectives. First, an underlying assumption of this literature is that individuals respond to contracts that reward performance. Accordingly, I consider whether agents behave in this way, and whether these responses are always in the firm's interest. Second, I address whether firms write contracts with these responses in mind. In other words, do contracts look like the predictions of the theory? Incentives are provided to workers

/pdf/the-provision-of-incentives-in-firms-zlx7fye09q.pdf

The Provision of Incentives in Firms

The Chamberlinian monopolistically competitive equilibrium has been explored and extended in a number of recent papers. These analyses have paid only cursory attention to the existence of an industry outside the Chamberlinian group. In this article I analyze a model of spatial competition in which a second commodity is explicitly treated. In this two-industry economy, a zero-profit equilibrium with symmetrically located firms may exhibit rather strange properties. First, demand curves are kinked, although firms make "Nash" conjectures. If equilibrium lies at the kink, the effects of parameter changes are perverse. In the short run, prices are rigid in the face of small cost changes. In the long run, increases in costs lower equilibrium prices. Increases in market size raise prices. The welfare properties are also perverse at a kinked equilibrium.

/pdf/monopolistic-competition-with-outside-goods-1wzanxmm2b.pdf

Monopolistic competition with outside goods

Bargains and Ripoffs: A Model of Monopolistically Competitive Price DispersionAuthor(s): Steven Salop and Joseph StiglitzSource: The Review of Economic Studies, Vol. 44, No. 3 (Oct., 1977), pp. 493-510Published by: The Review of Economic Studies Ltd.Stable URL: http://www.jstor.org/stable/2296903Accessed: 15/09/2009 15:43

/pdf/bargains-and-ripoffs-a-model-of-monopolistically-competitive-141lesiuht.pdf

Bargains and Ripoffs: A Model of Monopolistically Competitive Price Dispersion

Since the publication of Edmund Phelps' volume, the "new" macroeconomics has treated the labor market as a dynamic process of rational search by unemployed workers for available vacancies. Wages are viewed as at least potentially flexible, though free contracting between workers and firms may lead to fixed wages in the short run. Imperfect information is a crucial element of the theory, for it implies both a need for contracting and a need for rational search rather than simple market clearing in each period. A positive rate of frictional unemployment may exist in equilibrium, denoted as the "natural" rate. This unemployment is due to the frictions in the search process and imperfections in information rather than to any deficiency in aggregate demand. Milton Friedman defined the natural rate as

A Model of the Natural Rate of Unemployment

Self-Selection and Turnover in the Labor Market

This article analyzes the competition and integration among complementary products that can be combined to create composite goods or systems. The model generalizes the Cournot duopoly complements model to the case in which there are multiple brands of compatible components. It analyzes equilibrium prices for a variety of organizational and market structures that differ in their degree of competition and integration. The model applies to a variety of product networks, including automatic teller machines, real estate multiple listing services, and airlines CRS, as well as to nonnetwork markets of compatible components such as computer CPUs and peripherals, hardware and software, and long distance and local telephone services. Copyright 1992 by Blackwell Publishing Ltd.

Steven C. Salop

Papers

Monopolistic competition with outside goods

Bargains and Ripoffs: A Model of Monopolistically Competitive Price Dispersion

A Model of the Natural Rate of Unemployment

Self-Selection and Turnover in the Labor Market

Competition and integration among complements, and network market structure*