Real wages, productivity, and the cycle: An efficiency wage model

This paper extends the results of previous work that shows imperfect monitoring of worker effort can explain involuntary unemployment in equilibrium. The present paper assumes that the performance standard for worker effort is determined endogenously and that worker utility is quasi-linear in the wage and effort. In this setting, involuntary unemployment still arises in equilibrium, but the comparative static properties of equilibrium are fundamentally altered. First, aggregate productivity shocks directly affect the real wage and work effort. The model can thus explain pro-cyclical variations in real wages and labor productivity. Also, work effort increases with the level of unemployment income.