Equilibrium Wage and Employment Dynamics in a Model of Wage Posting Without Commitment

31 Pages Posted: 15 Aug 2011

See all articles by Melvyn G. Coles

Melvyn G. Coles

University of Essex - Department of Economics; Autonomous University of Barcelona; IZA Institute of Labor Economics

Dale T. Mortensen

Northwestern University - Department of Economics; IZA Institute of Labor Economics

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Abstract

A rich but tractable variant of the Burdett-Mortensen model of wage setting behavior is formulated and a dynamic market equilibrium solution to the model is defined and characterized. In the model, firms cannot commit to wage contracts. Instead, the Markov perfect equilibrium to the wage setting game, characterized by Coles (2001), is assumed. In addition, firm recruiting decisions, firm entry and exit, and transitory firm productivity shocks are incorporated into the model. Given that the cost of recruiting workers is proportional to firm employment, we establish the existence of an equilibrium solution to the model in which wages are not contingent on firm size but more productive employers always pay higher wages. Although the state space, the distribution of workers over firms, is large in the general case, it reduces to a scalar that can be interpreted as the unemployment rate in the special case of homogenous firms. Furthermore, the equilibrium is unique. As the dimension of the state space is equal to the number of firms types in general, an (approximate) equilibrium is computable.

Keywords: wage dispersion, wage setting, rank-preserving equilibrium

JEL Classification: D21, D49, E23, J42, J64

Suggested Citation

Coles, Melvyn G. and Mortensen, Dale T., Equilibrium Wage and Employment Dynamics in a Model of Wage Posting Without Commitment. IZA Discussion Paper No. 5900, Available at SSRN: https://ssrn.com/abstract=1909380

Melvyn G. Coles (Contact Author)

University of Essex - Department of Economics ( email )

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Autonomous University of Barcelona

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IZA Institute of Labor Economics

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Germany

Dale T. Mortensen

Northwestern University - Department of Economics ( email )

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United States
847-491-8230 (Phone)
847-491-7001 (Fax)

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

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