What are its unemployment implications

NC economic theory postulates that involuntary unemployment will eliminate over time by market forces and equilibrium restored by a fall in the wage rate.

Firms can artificially create involuntary unemployment if they choose to adopt efficiency wages that profit maximise at the firm level. Efficiency wages imply real wage rigidity that may prevent labour mkt equilibrium.

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There are various efficiency wages:

Solow condition recognises that there is a +ve relationship between wage and effort. Aim is to derive optimal wage rate such that elasticity of effort w.r.t. wage is = 1. A 1% increase in wage results in 1% increase in effort. This wage may be above mkt clearing wage thus involuntary unemployment may be generated. The level of unemployment is dependant on AD. Wages will not deviate from the optimal Solow wage regardless of economic activity. The derived wage minimises the cost per unit of efficiency.

Shirking (Shapiro & Stiglitz 1984) condition recognises that workers may work or shirk (not work) It may not be possible or be too costly for a firm to constantly monitor employees and may be demoralising for employees at work. A non-shirking wage rate is derived that is optimal in eliminating shirking. The wage is positively dependant on: lower the involuntary unemployment, higher the unemployment benefits, lower probability of shirking detection. Since higher unemployment benefits positively influence the non-shirking wage, such benefits increase unemployment!

Turnover model recognises that it is costly for firm to search, interview, train, contract etc of a new employee. The aim is to minimise on labour turnover costs such that to mitigate employees quitting for alternative jobs. This wage is likely to be above clearing wage hence involuntary unemployment. Even if all firms offer above mkt clearing wage, employee will incur a spell of unemployment until re-employed by another firm at the existing wage thus employee is discouraged from shirking.

Firms may adopt above mkt clearing wage to economise on adverse selection problems. Higher wage are likely to attract more productive labour. Firms may wish to set wage above mkt clearing wage in an attempt to achieve a more productive labour force.

Henry ford in the early 1900s adopted efficiency wages and paid employees a significantly higher wage than their next best alternative. Consequently, shirking mitigated and productivity increased resulting in increased profits.

Krueger found that franchised restaurants paid less than company owned restaurants due to better employee monitoring thus the need for efficiency wages are less than in company owned restaurants.

Efficiency wage models may contribute to profit maximisation at micro level, but they may predict involuntary unemployment that results in labour market disequilibrium. Employees that appreciate efficiency wages are likely to adopt them they are likely to increase profits and/or minimise on labour costs. Any other wage rate derived by either of the above efficiency wage models would contribute to sub-optimal wages at firm-level. Firms that rely on high specific training are likely to adopt efficiency wages, especially shirking and turnover efficiency models such as to maximise returns on specific training as employees are less likely to quit.