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Do Emotions Improve Labor Market Outcomes?

  • Götte, Lorenz

    ()

    (University of Bonn)

  • Huffman, David B.

    ()

    (University of Oxford)

This chapter argues that the neglect of emotion in economic models explains their inability to predict important aspects of the labor market. We focus on one example: firms frequently cut real wages, increasing nominal wages by less than the inflation rate, but they very seldom cut nominal wages. This pattern suggests that workers exhibit a special resistance to nominal wage cuts, which is hard to explain if they are purely rational as assumed in standard economic models. We argue that resistance to nominal wage cuts is best understood in terms of a model where salient features of a situation trigger emotional responses and sway judgment of the entire situation. Since a cut in the nominal wage leads to a very salient reduction in pay, we argue that the reaction of workers is dominated by emotions. On the other hand, an increase in the nominal wage may produce a more deliberative evaluation, because there is no immediately salient feature. The individual needs to compare the inflation rate to the wage change before it becomes clear whether the change increases or decreases utility, thus producing a more measured response. We present evidence from experiments showing that self-reported emotions respond strongly to nominal wage cuts, but not to decreases in the real wage achieved through increasing the nominal wage by less than the inflation rate. Although emotions may benefit individual workers, by strengthening their bargaining position and preventing wage cuts, they may also lead to worse outcomes, in the form of higher unemployment.

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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 1895.

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Length: 29 pages
Date of creation: Dec 2005
Date of revision:
Publication status: published in: Vohs, K.D, Baumeister, R.F; Loewenstein, G. (eds.): Do emotions help or hurt decision making? A Hedgefoxian Perspective, New York, Sage, 2007
Handle: RePEc:iza:izadps:dp1895
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  15. Beth Anne Wilson, 1999. "Wage rigidity: a look inside the firm," Finance and Economics Discussion Series 1999-22, Board of Governors of the Federal Reserve System (U.S.).
  16. Kahneman, Daniel & Knetsch, Jack L & Thaler, Richard, 1986. "Fairness as a Constraint on Profit Seeking: Entitlements in the Market," American Economic Review, American Economic Association, vol. 76(4), pages 728-41, September.
  17. David Card & Dean Hyslop, 1997. "Does Inflation "Grease the Wheels of the Labor Market"?," NBER Chapters, in: Reducing Inflation: Motivation and Strategy, pages 71-122 National Bureau of Economic Research, Inc.
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