We study how relational contracts mitigate Becker's classic problem of providing general human capital when training contracts are incomplete. The firm's profit-maximizing agreement is a multiperiod apprenticeship in which the novice is trained gradually over time and eventually receives all knowledge. The firm adopts a 1/e rule, whereby at the beginning of the relationship the novice is trained, for free, just enough to produce a fraction 1/e of the efficient output. After that, the novice earns all additional knowledge with labor. This rule causes inefficiently lengthy relationships that grow longer the more patient the players. A minimum wage is welfare enhancing.

The principal motivating factor in our lives is the pursuit of happiness. In most cultures, when seeking this end, individuals place a high priority on income, and spend much of their waking time procuring this intermediate goal. The connection between income and happiness is by no means trivial, however. Two critical factors come into play. First, beyond subsistence level, the positive effect of a permanent change in income tends to be short lived. We rapidly become accustomed to a more expensive lifestyle. A common name for this feature is habit formation. Second, the satisfaction derived from a given level of income is sharply dependent on how it compares to the income of peers. See, for example, Andrew B. Abel (1990), Becker (1996), and William A. Brock and Steven N. Durlauf (2001) for a demonstration of the influence of habits and peer comparisons over behavior, and see Shane Frederick and George Loewenstein (1999) for a review of the underlying psychology. Habits and peer comparisons mean that an individual is not concerned mainly with her absolute level of income, but rather with the difference between her income and a benchmark that changes over time. In recent years, economists have become increasingly interested in this fact. This interest has been both applied (i.e., the study of habits and peer influences over behavior and the analysis of happiness surveys) and theoretical (i.e., a search for biological foundations). But unlike other more developed areas of economics, these two approaches remain fairly separate from each other. In particular, the existing theoretical work is motivated only by the most basic empirical observations. And the existing applied work, for the most part, has not been influenced by theoretical results. In this essay, we seek to reduce the distance between these two literature strands. In particuHabits, Peers, and Happiness: An Evolutionary Perspective

A principal specifies time paths of effort provision, task allocation, and knowledge transfer for a cash-constrained apprentice, who is free to walk away at any time. In the optimal contract the apprentice pays for training by working for low or no wages and by working inefficiently hard. The apprentice can work on both knowledge-complementary and knowledge-independent tasks. We study the optimal time path of effort distortions and their impact on the knowledge transfer, and analyze the effect of regulatory limits on the length of apprenticeships and on how much effort apprentices are allowed to provide.