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Why do efficiency wages exist? What are its unemployment implications?
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Why do efficiency wages exist? 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. 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...
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