6.6, work and wages, the labor discipline
model. Before going through this section let me
give you an overview of this model. Every job market has two sides: on
one side there are workers and on the other side there are employers.
Employers offer wages to workers and in return they expect the workers to carry
out certain tasks and put a lot of effort
into their job. However, at the other end, the workers decide how much effort
they're going to put into their job, depending on the wage that is offered to
them. Now let's pause and go back and look at
the situation from a perspective of the employer.
Of course any employer wants to make sure that the workers
put 100 percent of their effort into their job.
They can do this potentially by doing different things, for instance they can
specify all the things they expect the workers to do
in their contract from day one, or they can
visually monitor the performance of their workers, or ask the workers to fill
out reports of what they've done on a
daily basis, but all these methods are very costly
and sometimes impossible depending on the nature of
the job. For instance, when it comes to computer programming, you cannot specify
all the things you expect from a programmer
in the contract from day one, or you cannot visually or
daily monitor the performance of a programmer. It doesn't make sense.
Therefore, there is a better way for the employers to motivate their workers to
work hard and that way is to give them high
enough wages to increase the employment rent for the workers. What do I mean by that?
Let's assume I am a computer programmer
for Google. If Google offers me a wage that is much
higher to the other competitors, let's say Facebook and
Apple, then I have an incentive to make sure that Google does not fire me,
and I don't lose my job. So I have an incentive to work hard:
I know that my boss in Google may not be able to
monitor my performance on a daily basis, but I know that in the long term he or
she can figure out whether I'm putting a lot of
effort into my job or not, so I have an incentive because of
high wages - because of the employment rent that Google is offering me to work
hard. Now with these insights in mind we're gonna go back to our model and
analyze the labor market from the perspective of the employee,
from the perspective of a worker. Here we have an example of one worker,
Maria, and we're to talk about her best
response curve. The x-axis represents the hourly wage
that is offered to Maria by her boss, and the y-axis represents
the level of effort that Maria decides to put into her job,
depending on the wage that is offered to her if she puts hundred percent of
effort. We represent this by one. Now the key information here is Maria's
reservation wage. If she decides to stay at home and not
to work at all, she gets paid six dollars per hour, so
in order to stay motivated and work hard she has to be
offered a wage that is at least higher than six dollars per hour.
This is Maria's best response curve. At the beginning this curve is very
steep but as the hourly wage and the effort
level increases this curve becomes flatter.
Why that's the case? Because we have to remember
that there is disutility associated with increasing your effort
level. Pushing yourself to work harder is
unenjoyable. Let's assume that I'm putting 10 percent of effort into
the job. Here I can be motivated to push myself
to work harder, with a small increase in wages, but the
story is different when I reach 0.8 level of my effort.
If i put 0.8 of effort into my job pushing myself to work harder becomes
much, much more unenjoyable, therefore I have
to be compensated by a bigger increase in wages.
In other words, the higher the effort level,
it becomes more unenjoyable to push yourself to work harder,
therefore you have to be compensated by a higher increase in wages,
and that's why this curve has this shape and we call the slope of these
curves, which is declining, the marginal rate of transformation -
transforming hourly wage into effort level.
Now let's look at the labor market from the perspective of an employer.
Let's scroll down and go to 6.7, wages, effort and profits in the labor
discipline model. Imagine that I'm an employer. I want to
maximize my profit. How do I do that? I try to make sure that
I get the maximum effort possible out of the
wage that I'm paying to my workers. How does that work?
Let's scroll down and use the same graph as before but think about the situation
from an employer's perspective.
The x-axis is the wage that I pay to my workers
and the y-axis is the effort that they're willing to put
into their job. Now I imagine a scenario in my head as an employer.
One scenario is that I pay $10 per hour
and the worker puts 0.45 units of effort. Now if I draw a line
here, all the dots that exist in this line
have the same effort to wage ratio - they give me the
same profit, so therefore I'm indifferent about all
these dots in this line and we call this line
an isocost line.
I can think about other scenarios as well, or other
isocost lines. Let's focus on this line. The slope of this line is less,
so therefore it gives me less profit, why? Because for the same wage that I
paid before I get lower effort in this line. What's the most
profitable line here? This one of course. It is the
steepest linem, it gives me the highest effort per wage.
If I pay the same wage as before in this scenario
I get a higher effort, so as an employer naturally I want to move to an
isocost line which is steeper and here we call the slope of the line
the marginal rate of substitution -
in other words my willingness to increase
wages to motivate my workers to work harder. So, so far
we started by analyzing the labor market from the perspective of a worker,
then we moved to the labor market from the perspective
of an employer. Now we're going to talk about the equilibrium.
Equilibrium happens when the willingness of the worker
matches the willingness of the employer. So let's scroll down
to analyze the equilibrium. Let's still imagine I'm the employer, and now
this time there is a real worker on the other side, Maria.
I offer a wage to Maria and Maria decides how much effort she's going to put into
her job depending on the wage. This is Maria's best response curve.
Remember, as an employer I don't see this curve, I
only offer a wage to Maria and can observe her effort every once in
a while in the medium term. Remember I cannot observe Maria's effort
on a daily basis but in the medium term I can
tell whether she's putting effort into a job or not.
So as an employer I offer a wage which is just a little bit above
the reservation to Maria. Maria starts working
and puts this level of effort into her job, point C,
but then after a while I realize that if I increase Maria's wage
she is willing to put more effort into her job and this makes more
profit for me, why? Because the pace of the increase in her
effort is higher than the pace in increase in wages. I repeat. The pace in the increase
in her effort is higher than pace in the increase in
in her wages until point A. Right here I make the most profit.
Now of course A is more profitable than C,
why? Because if we go back to our isocost line
C lies in a line which is costlier than this line.
Of course I wish I could move to this line which is the lowest cost line out
of the three, but that's beyond Maria's willingness to
work, so the equilibrium is A.
Here my willingness to pay higher wages for higher effort matches Maria's
willingness to work harder for a higher wage.
Now in the end let me end with this question:
how does this equilibrium change if suddenly a recession hits
and the unemployment shoots up?