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The Firm as a Community Explaining Asymmetric Behavior and Downward Rigidity of Wages

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    Abstract

    This paper models the firm as a community à la Akerlof (1980) to account for asymmetric behavior, and in particular, downward rigidity of wages. It is shown that, through social interaction among workers in the firm community, wage cuts can give rise to a large, discontinuous fall in labor productivity (known as “catastrophe”). Furthermore, this large fall in labor productivity will persist or display inertia (known as “hysteresis”) even if the wages are restored to the pre-cut level and beyond. Our catastrophe/hysteresis finding with respect to wage cuts can rationalize the downward rigidity of wage behavior, and is consistent with the interview evidence of fragile worker morale emphasized by Bewley (1999) and others in explaining why employers are sensitive to and refrain from cutting worker pay.

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    File URL: http://www.econ.sinica.edu.tw/upload/file/06-a014.2008090209395225.pdf
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    Bibliographic Info

    Paper provided by Institute of Economics, Academia Sinica, Taipei, Taiwan in its series IEAS Working Paper : academic research with number 06-A014.

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    Length: 28 pages
    Date of creation: Dec 2006
    Date of revision:
    Handle: RePEc:sin:wpaper:06-a014

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    Keywords: Wage rigidity; Firm community; Catastrophe; Hysteresis;

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    1. Agell, Jonas & Lundborg, Per, 1993. "Theories of Pay and Unemployment: Survey Evidence from Swedish Manufacturing Firms," Working Paper Series 380, Research Institute of Industrial Economics.
    2. George A. Akerlof & William R. Dickens & George L. Perry, 1996. "The Macroeconomics of Low Inflation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(1), pages 1-76.
    3. Palfrey, Thomas R., 2002. "Implementation theory," Handbook of Game Theory with Economic Applications, in: R.J. Aumann & S. Hart (ed.), Handbook of Game Theory with Economic Applications, edition 1, volume 3, chapter 61, pages 2271-2326 Elsevier.
    4. Dickens, William T, et al, 1989. "Employee Crime and the Monitoring Puzzle," Journal of Labor Economics, University of Chicago Press, vol. 7(3), pages 331-47, July.
    5. Albrecht, James W & Vroman, Susan B, 1998. "Nash Equilibrium Efficiency Wage Distributions," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(1), pages 183-203, February.
    6. Harry J. Holzer & Edward B. Montgomery, 1990. "Asymmetries and Rigidities in Wage Adjustments by Firms," NBER Working Papers 3274, National Bureau of Economic Research, Inc.
    7. 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.
    8. George A. Akerlof, 1978. "A theory of social custom, of which unemployment may be one consequence," Special Studies Papers 118, Board of Governors of the Federal Reserve System (U.S.).
    9. Ernst Fehr & Simon Gaechter, 2000. "Fairness and Retaliation: The Economics of Reciprocity," CESifo Working Paper Series 336, CESifo Group Munich.
    10. Fehr, Ernst & Schmidt, Klaus M., 2001. "Theories of Fairness and Reciprocity," Discussion Papers in Economics 14, University of Munich, Department of Economics.
    11. Bewley, Truman F., 1998. "Why not cut pay?," European Economic Review, Elsevier, vol. 42(3-5), pages 459-490, May.
    12. Alan S. Blinder & Don H. Choi, 1989. "A Shred of Evidence on Theories of Wage Stickiness," NBER Working Papers 3105, National Bureau of Economic Research, Inc.
    13. Peter Howitt, 2002. "Looking Inside the Labor Market: A Review Article," Journal of Economic Literature, American Economic Association, vol. 40(1), pages 125-138, March.
    14. Elster, Jon, 1989. "Social Norms and Economic Theory," Journal of Economic Perspectives, American Economic Association, vol. 3(4), pages 99-117, Fall.
    15. Campbell, Carl M, III & Kamlani, Kunal S, 1997. "The Reasons for Wage Rigidity: Evidence from a Survey of Firms," The Quarterly Journal of Economics, MIT Press, vol. 112(3), pages 759-89, August.
    16. Shafir, Eldar & Diamond, Peter & Tversky, Amos, 1997. "Money Illusion," The Quarterly Journal of Economics, MIT Press, vol. 112(2), pages 341-74, May.
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