6.6, work and wages, the labor discipline

model. Before going through this section let me

give you an overview of this model.
Every job market has two sides: on

one side there are workers and on the
other side there are employers.

Employers offer wages to workers and in
return they expect the workers to carry

out certain tasks and put a lot of
effort

into their job. However, at the other end,
the workers decide how much effort

they're going to put into their job,
depending on the wage that is offered to

them.
Now let's pause and go back and look at

the situation from a perspective of the
employer.

Of course any employer wants to make
sure that the workers

put 100 percent of their effort into
their job.

They can do this potentially by doing
different things, for instance they can

specify all the things they expect the
workers to do

in their contract from day one, or they
can

visually monitor the performance of
their workers, or ask the workers to fill

out reports of what they've done on a

daily basis, but all these methods are very costly

and sometimes
impossible depending on the nature of

the job. For instance, when it comes to
computer programming, you cannot specify

all the things you expect from a
programmer

in the contract from day one, or you
cannot visually or

daily monitor the performance
of a programmer. It doesn't make sense.

Therefore, there is a better way for the
employers to motivate their workers to

work hard
and that way is to give them high

enough wages to increase the employment rent for the workers. What do I mean by that?

Let's assume I am a computer programmer

for Google. If Google offers me a wage that is much

higher to the other competitors, let's
say Facebook and

Apple, then I have an incentive to make
sure that Google does not fire me,

and I don't lose my job.
So I have an incentive to work hard:

I know that my boss in Google may not be
able to

monitor my performance on a daily basis,
but I know that in the long term he or

she can figure out whether I'm putting a lot of

effort into my job or not,
so I have an incentive because of

high wages - because of the employment rent that Google is offering me to work

hard. Now with these insights in mind
we're gonna go back to our model and

analyze the labor market
from the perspective of the employee,

from the perspective of a worker.
Here we have an example of one worker,

Maria, and we're to talk about her best

response curve.
The x-axis represents the hourly wage

that is offered to Maria by her boss, and
the y-axis represents

the level of effort that Maria decides
to put into her job,

depending on the wage that is offered to
her if she puts hundred percent of

effort. We represent this by one.
Now the key information here is Maria's

reservation wage.
If she decides to stay at home and not

to work at all, she gets paid six dollars per hour, so

in order to stay motivated and work hard
she has to be

offered a wage that is at least higher
than six dollars per hour.

This is Maria's best response curve.
At the beginning this curve is very

steep but as the hourly wage and the effort

level increases this curve becomes flatter.

Why that's the case? Because we have to
remember

that there is disutility associated with increasing your effort

level. Pushing yourself to work harder is

unenjoyable. Let's assume that
I'm putting 10 percent of effort into

the job. Here I can be motivated to push myself

to work harder, with a small increase in wages, but the

story is different when I reach 0.8 level of my effort.

If i put 0.8 of effort into my job
pushing myself to work harder becomes

much, much more unenjoyable, therefore I have

to be compensated by a bigger increase in wages.

In other words, the higher the effort
level,

it becomes more unenjoyable to push
yourself to work harder,

therefore you have to be compensated
by a higher increase in wages,

and that's why this curve has this
shape and we call the slope of these

curves, which is declining, the marginal rate of transformation -

transforming hourly wage
into effort level.

Now let's look at the labor market from
the perspective of an employer.

Let's scroll down and go to 6.7,
wages, effort and profits in the labor

discipline model.
Imagine that I'm an employer. I want to

maximize my profit.
How do I do that? I try to make sure that

I get the maximum effort possible out of the

wage that I'm paying to my workers. How does that work?

Let's scroll down and use the same graph
as before but think about the situation

from an employer's perspective.

The x-axis is the wage that I pay to my
workers

and the y-axis is the effort that
they're willing to put

into their job. Now I imagine a scenario
in my head as an employer.

One scenario is that I pay $10
per hour

and the worker puts 0.45
units of effort. Now if I draw a line

here, all the dots that exist in this line

have the same effort to wage ratio - they give me the

same profit, so therefore I'm indifferent about all

these dots in this line and we call this
line

an isocost line.

I can think about other scenarios as
well, or other

isocost lines. Let's focus on this line.
The slope of this line is less,

so therefore it gives me less profit,
why? Because for the same wage that I

paid before I get lower
effort in this line. What's the most

profitable line here?
This one of course. It is the

steepest linem,
it gives me the highest effort per wage.

If I pay the same wage as before in this
scenario

I get a higher effort, so as an
employer naturally I want to move to an

isocost line which is steeper
and here we call the slope of the line

the marginal rate of substitution -

in other words my willingness to
increase

wages to motivate my workers to work
harder. So, so far

we started by analyzing the labor
market from the perspective of a worker,

then we moved to the labor market from the perspective

of an employer. Now we're going to talk
about the equilibrium.

Equilibrium happens when the willingness
of the worker

matches the willingness of the employer.
So let's scroll down

to analyze the equilibrium. Let's still
imagine I'm the employer, and now

this time there is a real worker on the
other side, Maria.

I offer a wage to Maria and Maria decides
how much effort she's going to put into

her job depending on the wage.
This is Maria's best response curve.

Remember, as an employer I don't see this curve, I

only offer a wage to Maria
and can observe her effort every once in

a while in the medium term.
Remember I cannot observe Maria's effort

on a daily basis but in the medium term I can

tell whether she's putting effort into a
job or not.

So as an employer I offer a wage
which is just a little bit above

the reservation to Maria. Maria starts
working

and puts this level of effort into her
job, point C,

but then after a while I realize that
if I increase Maria's wage

she is willing to put more
effort into her job and this makes more

profit for me, why? Because
the pace of the increase in her

effort is higher than the pace in increase
in wages. I repeat. The pace in the increase

in her effort is higher than pace in the
increase in

in her wages until point A. Right here I make the most profit.

Now of course A is more profitable than
C,

why? Because if we go back to our isocost line

C lies in a line which
is costlier than this line.

Of course I wish I could move to this
line which is the lowest cost line out

of the three, but that's beyond Maria's willingness to

work, so the equilibrium is A.

Here my willingness to pay higher wages
for higher effort matches Maria's

willingness to work harder for a higher wage.

Now in the end let me end with this
question:

how does this equilibrium change if
suddenly a recession hits

and the unemployment shoots up?