A Theory of Efficiency Wage with Multiple Unemployment Equilibria: How a Higher Minimum Wage Law Can Curb Unemployment

38 Pages Posted: 23 May 2008

See all articles by Kaushik Basu

Kaushik Basu

Cornell University - Department of Economics; IZA Institute of Labor Economics; Brookings Institution

Amanda J. Felkey

Cornell University

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Abstract

This paper uses efficiency wage theory and the existence of community-based sharing to hypothesize that labor markets in developing countries have multiple equilibria - the same economy can be stuck at different levels of unemployment with different levels of wages. The model is meant for developing economies where wage-productivity links are discernible and income-sharing among the poor is prevalent. It seems reasonable to posit that in such an economy more unemployment leads to more income sharing. The main results are generated combining this claim with a theoretical demonstration of the fact that more sharing increases unemployment rates. As corollaries, we show that (1) within the same society, two different racial groups that may be ex ante identical can have different levels of unemployment and wages in equilibrium and (2) the imposition of a legal minimum wage can raise employment.

Keywords: unemployment, efficiency wage, minimum wage law, racial differences, South Africa

JEL Classification: J60, O12, D40

Suggested Citation

Basu, Kaushik and Felkey, Amanda J., A Theory of Efficiency Wage with Multiple Unemployment Equilibria: How a Higher Minimum Wage Law Can Curb Unemployment. IZA Working Paper No. 3381, Available at SSRN: https://ssrn.com/abstract=1136186 or http://dx.doi.org/10.1111/j.0042-7092.2007.00700.x

Kaushik Basu (Contact Author)

Cornell University - Department of Economics ( email )

414 Uris Hall
Ithaca, NY 14853-7601
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IZA Institute of Labor Economics

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Germany

Brookings Institution ( email )

1775 Massachusetts Ave, NW
Washington, DC 20036
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Amanda J. Felkey

Cornell University ( email )

Ithaca, NY 14853
United States

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