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Investigating Rationality in Wage-Setting

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Author Info
Sonia R Bhalotra

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Abstract

This paper investigates the efficiency wage hypothesis and derives a tractable expression for the profit loss incurred by deviations from the efficiency wage. The extent of the wage deviation can be inferred from production function parameters. The resulting profit loss shown to depend upon the curvature of th effort function and the employment and wage elasticities of output. If the profit loss is small then near rationality may be claimed even if the hypothesis of rationality is statistically rejected. An application to Indian manufacturing is presented, which suggests that rationality cannot be rejected and that the profit function is remarkably flat aroung the optimum. This is consistent with positive effort returns to increasing the wage beyond its efficient level.

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Paper provided by Suntory and Toyota International Centres for Economics and Related Disciplines, LSE in its series STICERD - Development Economics Papers with number 10.

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Date of creation: Feb 1998
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Handle: RePEc:cep:stidep:10

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Related research
Keywords: Efficiency wage; near-rationality; panel data; India.;

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  1. Levine, David I, 1992. "Can Wage Increases Pay for Themselves? Tests with a Production Function," Economic Journal, Royal Economic Society, vol. 102(414), pages 1102-15, September. [Downloadable!] (restricted)
  2. John H. Cochrane, 1989. "The Sensitivity of Tests of the Intertemporal Allocation of Consumption to Near-Rational Alternatives," NBER Working Papers 2730, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  3. Arellano, Manuel & Bond, Stephen, 1991. "Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations," Review of Economic Studies, Blackwell Publishing, vol. 58(2), pages 277-97, April. [Downloadable!] (restricted)
  4. Akerlof, George A, 1982. "Labor Contracts as Partial Gift Exchange," The Quarterly Journal of Economics, MIT Press, vol. 97(4), pages 543-69, November. [Downloadable!] (restricted)
  5. Shapiro, Carl & Stiglitz, Joseph E, 1984. "Equilibrium Unemployment as a Worker Discipline Device," American Economic Review, American Economic Association, vol. 74(3), pages 433-44, June. [Downloadable!] (restricted)
  6. Akerlof, George A, 1984. "Gift Exchange and Efficiency-Wage Theory: Four Views," American Economic Review, American Economic Association, vol. 74(2), pages 79-83, May. [Downloadable!] (restricted)
  7. Akerlof, George A & Yellen, Janet L, 1985. "Can Small Deviations from Rationality Make Significant Differences to Economic Equilibria?," American Economic Review, American Economic Association, vol. 75(4), pages 708-20, September. [Downloadable!] (restricted)
  8. Alan B. Krueger & Lawrence H. Summers, 1987. "Reflections on the Inter-Industry Wage Structure," NBER Working Papers 1968, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  9. Salop, Steven C, 1979. "A Model of the Natural Rate of Unemployment," American Economic Review, American Economic Association, vol. 69(1), pages 117-25, March. [Downloadable!] (restricted)
  10. Muellbauer, John, 1984. "Aggregate Production Functions and Productivity Measurement: A New Look," CEPR Discussion Papers 34, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  11. Lawrence F. Katz, 1986. "Efficiency Wage Theories: A Partial Evaluation," NBER Working Papers 1906, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  12. Stiglitz, Joseph E, 1974. "Alternative Theories of Wage Determination and Unemployment in LDC'S: The Labor Turnover Model," The Quarterly Journal of Economics, MIT Press, vol. 88(2), pages 194-227, May. [Downloadable!] (restricted)
  13. Weiss, Andrew W, 1980. "Job Queues and Layoffs in Labor Markets with Flexible Wages," Journal of Political Economy, University of Chicago Press, vol. 88(3), pages 526-38, June. [Downloadable!] (restricted)
  14. Griliches, Zvi & Hausman, Jerry A., 1986. "Errors in variables in panel data," Journal of Econometrics, Elsevier, vol. 31(1), pages 93-118, February. [Downloadable!] (restricted)
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  15. Bhalotra, Sonia R, 1998. "The Puzzle of Jobless Growth in Indian Manufacturing," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 60(1), pages 5-32, February.
  16. Akerlof, George A, 1979. "Irving Fisher on His Head: The Consequences of Constant Threshold-Target Monitoring of Money Holdings," The Quarterly Journal of Economics, MIT Press, vol. 93(2), pages 169-87, May. [Downloadable!] (restricted)
  17. Paul P. Streeten, 1989. "Poverty," Boston University - Institute for Economic Development 6, Boston University, Institute for Economic Development.
  18. William T. Dickens, 1986. "Wages, Employment and the Threat of Collective Action by Workers," NBER Working Papers 1856, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  19. Akerlof, George A & Yellen, Janet L, 1985. "A Near-rational Model of the Business Cycle, with Wage and Price Intertia," The Quarterly Journal of Economics, MIT Press, vol. 100(5), pages 823-38, Supp.. [Downloadable!] (restricted)
  20. Demsetz, Harold, 1973. "Industry Structure, Market Rivalry, and Public Policy," Journal of Law & Economics, University of Chicago Press, vol. 16(1), pages 1-9, April.
  21. Craine, Roger, 1973. "On the Service Flow from Labour," Review of Economic Studies, Blackwell Publishing, vol. 40(11), pages 39-46, January. [Downloadable!] (restricted)
  22. Aggarwal Ashok K, 1991. "Estimates of Fixed Capital Stock in Registered Manufacturing Sector in India," IIMA Working Papers 937, Indian Institute of Management Ahmedabad, Research and Publication Department.
  23. Bhalotra, Sonia R., 1998. "Changes in utilization and productivity in a deregulating economy," Journal of Development Economics, Elsevier, vol. 57(2), pages 391-420. [Downloadable!] (restricted)
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