Answer to Question #65629 in Macroeconomics for Athira

Question

Classify various theories of unemployment based on the possible responses of the firm

Answer 1

Efficiency-wage theories suppose that firms can pay larger wage than market-equilibrium level. This may take place when firms try to increase effectiveness of employees or attract more qualified workforce. To stimulate workers for better performance each firm would like to pay an efficiency wage higher than its competitors. If all firms do so, then aggregate wages in the economy are higher than competitive market clearing level and labor supply becomes excessive, leaving some workers unemployed.

Implicit contract theories propose the existence of quantity adjustments instead of price adjustments in the labor market. According to these theories firms can response to fluctuations in labor demand through layoffs and overtime. They offer implicit insurance (contracts) to employees against income uncertainty. Such contracts make workers to be less sensitive to income changes.

Insider-outsider theories recognize that employed workers (insiders) have some bargaining power. Such status of individuals who are currently working leads to different from competitive pattern of wages and employment. Senior workers may get effective insurance via contract while new hires don’t. Therefore, outsiders are less productive and lose their jobs.