Macroeconomics 6

Let repeat something important about unemployment from the introductory economics
Unemployment can be
frictional, structural and cyclical;
voluntary and involuntary;
- Classical (because of higher wages) and Keynesian (because of lack of aggregate demand)…

Do you remember what is asymmetric information?
?

The Shapiro – Stiglitz model or “shirking” model: the basic idea
Because of asymmetric information firms do not know what the workers do on the job.
Workers do not like to work; in other words, the efforts generate disutility for workers.
Firms cannot control behavior of the workers, and the latter have opportunities to shirk.
Firms prefer to set higher wages in order to discourage propensity to shirk (Shapiro and Stiglitz, 1984).

Some words about “efficiency wage” theory
This situation is the special case of “efficiency wage” theory: higher wage may increase not only cost but also revenue…
Profit = Revenue as a function of wages – Cost as a function of wages
The idea of the efficiency wage theory is that increasing wages can lead to increased labor productivity because workers feel more motivated to work with higher pay.
Therefore, if firms increase wages – some or all of the higher wage costs will be recouped through increased staff retention and higher labor productivity.

The Shapiro – Stiglitz model: the basic assumptions
An individual worker’s utility function is:
U = w – e
that is: Utility = Wage minus Efforts
A typical worker enjoys wage but suffers making any efforts.
And he or she faces with the choice:
to shirk [to be shirker] (e=0) or not to shirk [to be non-shirker] (e>0)
The goal of a employer is to create incentives that provide situation when the utility of a non-shirker is not less than the utility of a shirker.

Please think at home (as part of preparation for The Final Exam)
Are these assumption consistent with:
The Islamic ethic?
The Confucian ethics?
The ethical standards of South Korean and Japanese corporations?

“Lyrical digression”: how can we calculate “benefits” from (financial) assets’ holding?

The important question
Is your job like an asset?

The essential formulas (Part 1)

The essential formulas (Part 2)

Some important conclusions

The essential formulas (Part 3)

The essential formulas (Part 4)

The essential formulas (Part 5)

The aggregate No-Shirking Constraint or formula (11) graphically

The NSC curve: important features/questions
NSC curve is a very special analogue to the labor supply curve…
Why is the NSC curve positively sloping?
Why is the NSC curve convex?
Is the NSC curve consistent with the guaranteed employment?
What are differences between NSC curve and typical Neoclassical economics-based labor supply curve?

The algebra of the equilibrium in the Shapiro – Stiglitz model

The equilibrium graphically

Involuntary unemployment in the Shapiro – Stiglitz model

Changes in the equilibrium

Some additional conclusions
The nominal wages in the modern capitalist economy are characterized by downward inflexibility. In other words, it is difficult to decrease nominal wage rate. One of the reasons for it is the employers’ aspirations to discourage employees’ shirking.
When the recession starts and aggregate demand falls, the firms (the employers) will react not by decreasing wages but by dismissing workers.

So…
Did you understand why unemployment can be a consequence of the normal operation of the mechanism of a market economy – in the conditions of asymmetric information?