In this paper, we argue that important labor market phenomena can be better understood if one takes (i) the inherent incompleteness and relational nature of most employment contracts and (ii) the existence of reference-dependent fairness concerns among a substantial share of the population into account. Theory shows and experiments confirm, that even if fairness concerns were only to exert weak effects in one-shot interactions, repeated interactions greatly magnify the relevance of such concerns on economic outcomes. We also review evidence from laboratory and field experiments examining the role of wages and fairness on effort, derive predictions from our approach for entry-level wages and incumbent workers' wages, confront these predictions with the evidence, and show that reference-dependent fairness concerns may have important consequences for the effects of economic policies such as minimum wage laws.
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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number
3901.
Length: 48 pages Date of creation: Dec 2008 Date of revision: Publication status: forthcoming in: Annual Review of Economics, 2009 Handle: RePEc:iza:izadps:dp3901
Find related papers by JEL classification: C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory D00 - Microeconomics - - General - - - General D2 - Microeconomics - - Production and Organizations D8 - Microeconomics - - Information, Knowledge, and Uncertainty J2 - Labor and Demographic Economics - - Demand and Supply of Labor L2 - Industrial Organization - - Firm Objectives, Organization, and Behavior
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