Efficiency Wage Theory
Why firms pay above market, morale, effort, and unemployment as a discipline device.
Definition
Theories of why firms rationally pay ABOVE market-clearing wages: to motivate effort, cut turnover, attract quality, or make job loss costly (Shapiro-Stiglitz shirking model).
Key equation
Solow condition: elasticity of effort with respect to wage = 1 at the optimum
The intuition
If getting fired costs you nothing (identical job next door), why work hard? Paying above market makes the job worth keeping, but if every firm does it, wages sit above clearing and unemployment itself becomes the discipline device.
Exam tip
Efficiency wages explain INVOLUNTARY unemployment in equilibriumequilibriumThe point where opposing forces balance, quantity supplied equals quantity demanded, so there's no pressure for price to change., the wage won't fall even with queues at the gate.
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