A Theory of Wage Setting Behaviour

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Abstract

In this paper we provide a micro-foundation for wage rigidity in a simple and tractable model of wage setting behavior, inspired by a synthesis of recent convergent insights from anthropological and experimental research, and drawing on concepts advanced in the behavioral economics literature. The core principles underlying our theory are contractual incompleteness, fairness, reciprocity, and reference dependence and loss aversion in the evaluation of wage contracts by workers. The model establishes a wage-effort relationship that captures a worker’s asymmetric reference-dependent reciprocity, in which loss aversion implies effort responds more strongly to wage changes below the reference wage than above it. This basic relationship gives rise to wage rigidity around a worker’s reference wage. We explore these implications further in a simple dynamic stochastic environment in which a worker adapts their feelings of entitlement once they become employed. The model allows us to shed new light on the importance of anticipated negative reciprocity and the cost of wage rigidity for a farsighted firm’s hiring and wage setting behavior.
Original languageEnglish
Place of PublicationGlasgow
PublisherUniversity of Strathclyde
Pages1-55
Number of pages56
Volume15
Publication statusPublished - 17 Feb 2016

Keywords

  • wage setting behavior
  • wage-effort relationship
  • asymmetric reference-dependent reciprocity

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    Fongoni, M., & Dickson, A. (2016). A Theory of Wage Setting Behaviour. (05 ed.) (pp. 1-55). University of Strathclyde.