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Stoch 3

The document discusses the concept of efficiency wages, where firms pay higher wages to ensure employees remain productive. It models worker states (active, shirking, unemployed) and their decision-making based on utility derived from wages and effort. The document also explores the employer's perspective, including profit maximization and conditions for hiring workers, while posing several mathematical problems related to the model.

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6 views2 pages

Stoch 3

The document discusses the concept of efficiency wages, where firms pay higher wages to ensure employees remain productive. It models worker states (active, shirking, unemployed) and their decision-making based on utility derived from wages and effort. The document also explores the employer's perspective, including profit maximization and conditions for hiring workers, while posing several mathematical problems related to the model.

Uploaded by

haidaica9981
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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probability theory → stochastic processes FFF

Efficiency Wages
It is increasing practice in modern times for firms to pay “efficiency wages” to keep their employees happy
enough that they are active on the job. This problem explores a simple model that explains the reasoning
behind efficiency wages.
Let’s begin by looking at the workers. The state space of any given worker can be approximated as

Ωworker = {A, S, U},

where A means the worker is actively working, S means the worker is shirking (not working, but employed),
and U means the worker is unemployed. Let us approximate that an unemployed worker will gain a job
as a (stopped) Poisson process with rate λ, an A worker will lose their job with rate µ, and a S worker
will lose their job with rate µ + ν.
Workers make decisions based on utility. Given the path ω(t) of a given worker through state space,
we can define
Z∞
U [ω] = dt u(ω(t))e−ρt
0
where the random variable u(t) is the utility rate per unit time that the worker has in state ω, which we
assume takes the following simple form:

u(A) = w − e
u(S) = w
u(U) = 0

where e is a measure of the effort exerted by workers, and w is the wage they are paid. Let us also define
the function
V (ω0 ) ≡ hU [ω(t)]|ω(0) = ω0 i
for each ω0 ∈ Ωworker .
(a) Explain why V (ω0 ) is t-independent, and
* Zτ +
V (ω0 ) = dt u(ω(t))e−ρt + V (ω(τ ))e−ρτ ω(0) = ω0 .
0

(b) Take the derivative of this expression with respect to τ , at τ = 0, given each possible initial state.
This will allow you to compute the function V .
Now, let’s look at things from the employer’s perspective. Assume that there are N firms, and each
firm employs about l workers on average. The economy has LT workers in total. Firms will choose w so
that V (A) is not smaller than V (S): thus, it expects all its workers to be in the A state.
(c) Show that the firm will pick wages so that
e
V (A) = V (U) + .
ν
(d) Express λ in terms of µ, N , l and LT .

(e) Determine w in terms of e, µ, ρ, N , l and LT .

The employer’s profit is given by


π = f (el) − wl
where f is a monotonically increasing, concave down function.

(f) Assuming the employer is profit maximizing, find the condition for how many workers the firm will
hire.

(g) Sketch a plot of l vs. w along with the regions where the firm is profit maximizing, as well as where
the workers are not shirking.

(h) Determine whether an increase in each of the following variables will cause w to rise: LT , ν, e, N .

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