Knowledge that Transforms

A dynamic, equilibrium model of long term (implicit) labour contracts under incomplete but symmetric information is developed. Workers are assumed to be risk averse and of unknown ability or productivity. Risk neutral firms learn, as do workers, about each worker's productivity by observing the worker's output over time. It is shown that equilibrium contracts provide for wages which never decline with age and increase only when the worker's market value increases above his current wage. In addition to characterizing the equilibrium wage contract, we also derive some of its implications for the behaviour of aggregate wages across various groups of workers. These implications explain some findings in the recent empirical literature on age-earnings profiles. In particular our model can explain why earnings may be positively related to experience even after controlling for productivity, as some empirical studies have indicated.

This paper generalizes the Durbin-Watson type statistics to test the OLS residuals from the fixed effects model for serial independence. Also generalized are the tests proposed by Sargan and Bhargava for the hypothesis that the residuals form a random walk. A method for efficient estimation of the parameters is also developed. Finally, an earnings function is estimated using the Michigan Survey of Income Dynamics in order to illustrate the uses of the tests and the estimation procedures developed in this paper.

Using a simple search technology and the Nash bargaining solution, the paper derives the steady state equilibrium negotiated wage as a function of the equilibrium unemployment and vacancy rates. For this wage, the lifetime expected present discounted value of earnings of a new worker is compared with the social marginal product of a new worker. These are not generally equal implying inefficient incentives for labour mobility.

This paper studies the consequences for the behaviour of aggregate output of the perception on the part of firms that changing prices is costly. The rational expectations equilibrium of an economy with many such firms is constructed. It is shown that in this economy nominal shocks have a persistent effect on aggregate output. Furthermore, the real wage is demonstrated to move procyclically in such an economy.

The notion of a Perfect Equilibrium in a multi-stage game is used to characterize industry equilibrium under Monopolistic Competition, where products are differentiated by quality.