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Efficiency Wages, Increasing Returns and Endogenous Fluctuations

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  • Rui Coimbra
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    Abstract

    This work studies the implications of efficiency wages, indivisible labour and increasing returns to endogenously create time series for real wages and employment exhibiting persistent fluctuations with a cyclical behavioiur similar to the one empirically observed. Our first result relates to the effects of introducing efficiency wages into a general equilibrium model. We show that this real wage rigidity can indeed explain involuntary unemployment but cannot affect the dynamical properties of an economic system. Hence, the remaining of the paper concerns basically to the role of indivisible labour and increasing returns to the occurrence of endogenous fluctuations. Our main results are: (i) when both constant returns and a standard elasticity of labour supply are considered, a small substitutability between factors is needed to generate endogenous fluctuations; this is just a replication of Reichlin (1986); (ii) the introduction of increasing returns is able to establish the possibility of endogenous fluctuations, even when the elasticity of inputs substitution is relatively large; but as in Cazzavilan et al (1998), the amount of increasing returns necessary to get this result is still large; (iii) the introduction of the indivisible labour hypothesis can generate endogenous fluctuations with both an elasticity of inputs substitution and an amount of increasing returns in consonance with empiricial evidence. Moreover, in this latter case we replicate two labour market regularities not usually captured by general equilibrium models: 1) employment is more volatile than real wages and 2) real wages are acyclical.

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    Paper provided by Department of Economics, University of York in its series Discussion Papers with number 99/6.

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    Handle: RePEc:yor:yorken:99/6

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    1. Danthine, Jean-Pierre & Donaldson, John B., 1990. "Efficiency wages and the business cycle puzzle," European Economic Review, Elsevier, vol. 34(7), pages 1275-1301, November.
    2. Jean-Michel Grandmont & P, A, Pintus & R, De Vilder, 1997. "Capital-Labor Substitution and Competitive Nonlinear Endogenous Business Cycles," Working Papers 97-28, Centre de Recherche en Economie et Statistique.
    3. Hansen, Gary D., 1985. "Indivisible labor and the business cycle," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 309-327, November.
    4. Christiano, Lawrence J & Eichenbaum, Martin, 1992. "Current Real-Business-Cycle Theories and Aggregate Labor-Market Fluctuations," American Economic Review, American Economic Association, vol. 82(3), pages 430-50, June.
    5. P. Diamond, 1980. "Aggregate Demand Management in Search Equilibrium," Working papers 268, Massachusetts Institute of Technology (MIT), Department of Economics.
    6. Roger E.A. Farmer & Jang Ting Guo, 1992. "Real Business Cycles and the Animal Spirits Hypothesis," UCLA Economics Working Papers 680, UCLA Department of Economics.
    7. Cazzavillan, Guido & Lloyd-Braga, Teresa & Pintus, Patrick, 1996. "Multiple steady states and endogenous fluctuations with increasing returns to scale in production," CEPREMAP Working Papers (Couverture Orange) 9618, CEPREMAP.
    8. Grandmont Jean-michel, 1983. "On endogenous competitive business cycles," CEPREMAP Working Papers (Couverture Orange) 8316, CEPREMAP.
    9. Caballero, Ricardo J. & Lyons, Richard K., 1992. "External effects in U.S. procyclical productivity," Journal of Monetary Economics, Elsevier, vol. 29(2), pages 209-225, April.
    10. George W. Stadler, 1994. "Real Business Cycles," Journal of Economic Literature, American Economic Association, vol. 32(4), pages 1750-1783, December.
    11. Solow, Robert M., 1979. "Another possible source of wage stickiness," Journal of Macroeconomics, Elsevier, vol. 1(1), pages 79-82.
    12. Reichlin, Pietro, 1986. "Equilibrium cycles in an overlapping generations economy with production," Journal of Economic Theory, Elsevier, vol. 40(1), pages 89-102, October.
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    Cited by:
    1. Joydeep Bhattacharya & Shankha Chakraborty, 2003. "What do Information Frictions do?," University of Oregon Economics Department Working Papers 2003-4, University of Oregon Economics Department.
    2. M Guerrazzi, 2008. "A Dynamic Efficiency-Wage Model with Continuous Effort and Externalities," Economic Issues Journal Articles, Economic Issues, vol. 13(2), pages 37-58, September.

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