The labour discipline model presents the firm's social interaction as a sequential game between employers and employees, aiming to solve the problem of incentivizing hard work. The model shows that firms can motivate effort by offering a wage with an employment rent, which is lost upon dismissal. A foundational assumption of this model is that employees assess the risk of being fired for shirking by using an expected detection time (`s`), despite the event being inherently a matter of chance. A key output of the model is the no-shirking wage curve, which specifies the minimum wage needed at different employment levels to deter shirking.

The Labour Discipline Model

The no-shirking wage is the wage a firm must set to ensure an employee chooses to work hard rather than shirk. It must be high enough to make the value of working hard greater than the value of taking the job and shirking until caught. This is necessary because firms cannot immediately detect a shirking worker, so the wage must include an employment rent to create a significant cost of job loss.

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The reservation wage is the specific wage at which a job offer holds the exact same value as the worker's next best alternative, such as remaining unemployed to search for another job. It functions as the minimum acceptable wage, establishing a clear decision rule: a worker will accept any offer with a wage greater than or equal to their reservation wage and reject any offer below it. For an unemployed individual, this value is determined by the income they receive while unemployed and the expected wages from a future job.

Reservation Wage

Employment rent is a form of economic rent that a worker receives when the net value of their job—accounting for all benefits and costs—surpasses the value of their next best alternative, which is typically being unemployed and searching for another job. It is calculated as the difference between the net benefit of employment and the net benefit of being unemployed. The existence of this rent is why workers have a strong interest in keeping their jobs.

Employment Rent (Cost of Job Loss)

To cite the ebook, use The CORE Econ Team 2023 The Economy 2.0: Microeconomics Open access e-text https://core-econ.org/the-economy/.

To cite a unit, use The CORE Econ Team 2023 The Economy 2.0: Microeconomics Open access e-text https://core-econ.org/the-economy/ Unit [unit number] (url).

CORE Econ - The Economy 2.0: Microeconomics

To cite the ebook, use The CORE Econ Team 2023 The Economy 2.0: Macroeconomics Open access e-text https://core-econ.org/the-economy/.

To cite a unit, use The CORE Econ Team 2023 The Economy 2.0: Macroeconomics Open access e-text https://core-econ.org/the-economy/ Unit [unit number] (url).

CORE Econ - The Economy 2.0: Macroeconomics

After evaluating her options, Françoise establishes a reservation wage of €600 per week, viewing unemployment as equivalent to a job paying this amount. This wage becomes her decision criterion. Since the advertised job offers €580, which is below her minimum threshold, she decides not to apply, thus rejecting the offer.

Françoise Rejects the €580 Offer Based on Her Reservation Wage

No-Shirking Wage

One way firms can motivate employees is by ensuring there is a significant cost to being fired. This cost, known as employment rent, can be increased by raising wages. A higher employment rent instills a fear of job loss in the employee, creating a powerful incentive to work hard to avoid being dismissed. Therefore, setting wages above the minimum required for recruitment becomes a key strategy for managers to ensure employee effort.

Raising Wages to Increase Employment Rent and Incentivize Effort

A worker's reservation wage is determined by any factor that affects the value of their next best alternative to employment. The core principle is that anything improving the opportunities available to an unemployed jobseeker will increase their reservation wage. These determinants can be grouped into two main categories: individual characteristics that define the worker's personal utility of being unemployed, and broader economy-wide conditions, such as the level of unemployment benefits and the overall ease of finding a new job.

Determinants of the Reservation Wage

The size of the employment rent needed to deter shirking is positively related to two key factors: the cost of effort (`c`) and the expected duration of shirking before detection (`s`). A higher cost of effort must be compensated by a larger rent. Similarly, a longer expected shirking period (a high `s`), often resulting from difficult monitoring, strengthens the temptation to shirk and thus requires a larger employment rent to make working hard the more attractive option.

Positive Relationship Between Employment Rent, Cost of Effort (c), and Shirking Duration (s)

Employment rents provide significant advantages to a company's owners and managers. The existence of this rent is a key reason why employers may structure compensation to create it, as it serves as a tool within the employer-employee relationship.

Benefits of Employment Rents for Owners and Managers

An employer or owner's power over their employees and managers stems from the existence of employment rent. Because the employer has the right to terminate employment, they can threaten to eliminate this rent. This threat of job loss serves as a powerful motivator, compelling workers and managers to comply with the firm's expectations. The same principle applies to managers, over whom owners wield power due to their ability to fire them and remove their managerial employment rents.

Employer Power Over Workers and Managers via Employment Rents

To determine the employment rent, or net cost of job loss, one must evaluate and compare all the benefits and costs of a job with the alternative of being unemployed. However, this estimation process is not simple. The complexity stems largely from the need to account for significant but hard-to-measure factors, such as the psychological and social costs associated with unemployment, which makes a precise calculation challenging.

Calculating Employment Rent

When evaluating a job, it is crucial to consider the various costs associated with being employed. These costs are a key factor in the calculation of employment rent, as they must be weighed against the job's benefits to determine its true net value to an employee.

Costs of Working

Employment offers various advantages that an individual forfeits upon becoming unemployed. These benefits, which would be lost in the event of job loss, are a critical component to consider when evaluating the overall value of a job and calculating employment rent.

Benefits of Working

The total cost associated with losing a job is not a fixed value; it is directly determined by the length of time an individual remains unemployed. The longer the period of joblessness, the greater the cumulative financial and non-financial losses, which in turn increases the overall cost of job loss.

Dependence of Total Cost of Job Loss on Unemployment Duration

Under the principle of ceteris paribus, which means all other factors are held constant, this problem asks to identify the specific employment conditions that would result in a high employment rent.

Conditions for High Employment Rent

The total cost of job loss is defined as being equal to the total employment rent. In Maria's specific case, this value amounts to \$10,080.

Equivalence of Total Cost of Job Loss and Total Employment Rent

In the labour discipline model, a simplifying assumption is made that the factors determining the wage premium required to ensure worker effort are the same for all employees. This leads to a uniform additional payment above the reservation wage for every worker. Graphically, this assumption is represented by the no-shirking wage (NSW) curve being a fixed vertical distance above the reservation wage curve.

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