Editing New Keynesian economics (section)

==== Labor market failures: Efficiency wages ====

New Keynesians offered explanations for the failure of the labor market to clear. In a Walrasian market, unemployed workers bid down wages until the demand for workers meets the supply.<ref>Romer (2005), p. 438</ref> If markets are Walrasian, the ranks of the unemployed would be limited to workers transitioning between jobs and workers who choose not to work because wages are too low to attract them.<ref>Romer (2005) pp. 437–439</ref> They developed several theories explaining why markets might leave willing workers unemployed.{{sfn|Romer|2005|p=437}} The most important of these theories was the [[efficiency wages|efficiency wage theory]] used to explain [[hysteresis (economics)|long-term effects of previous unemployment]], where short-term increases in unemployment become permanent and lead to higher levels of unemployment in the long-run.<ref>Snowdon, Brian; Vane, Howard (2005). ''Modern Macroeconomics''. Cheltenham, UK: Edward Elgar. {{ISBN|978-1-84542-208-0}}. p. 384</ref>

[[File:Efficiency wage Shapiro Stiglitz.svg|class=skin-invert-image|thumb|right|alt=Chart showing the relationship of the non-shirking condition and full employment|In the Shapiro-Stiglitz model workers are paid at a level where they do not shirk, preventing wages from dropping to full employment levels. The curve for the no-shirking condition (labeled NSC) goes to infinity at full employment.]]
In efficiency wage models, workers are paid at levels that maximize productivity instead of clearing the market.<ref>Froyen, Richard (1990). ''Macroeconomics, Theories and Policies'' (3rd ed.). New York: Macmillan. {{ISBN|978-0-02-339482-9}}. p. 357</ref> For example, in developing countries, firms might pay more than a market rate to ensure their workers can afford enough nutrition to be productive.<ref>Romer (2005), p. 439</ref> Firms might also pay higher wages to increase loyalty and morale, possibly leading to better productivity.<ref>Froyen (1990), p. 358</ref> Firms can also pay higher than market wages to forestall shirking. Shirking models were particularly influential.<ref>Romer (2005), p. 448</ref>[[Carl Shapiro]] and [[Joseph Stiglitz]]'s 1984 paper "Equilibrium Unemployment as a Worker Discipline Device" created a model where employees tend to avoid work unless firms can monitor worker effort and threaten slacking employees with unemployment.<ref>{{cite journal | last1 = Shapiro | first1 = C. | last2 = Stiglitz | first2 = J. E. | year = 1984 | title = Equilibrium Unemployment as a Worker Discipline Device | journal = The American Economic Review | volume = 74 | issue = 3| pages = 433–444 | jstor = 1804018 }}</ref><ref>Snowden and Vane (2005), p. 390</ref> If the economy is at full employment, a fired shirker simply moves to a new job.<ref>Romer (2005), p. 453.</ref> Individual firms pay their workers a premium over the market rate to ensure their workers would rather work and keep their current job instead of shirking and risk having to move to a new job. Since each firm pays more than market clearing wages, the aggregated labor market fails to clear. This creates a pool of unemployed laborers and adds to the expense of getting fired. Workers not only risk a lower wage, they risk being stuck in the pool of unemployed. Keeping wages above market clearing levels creates a serious disincentive to shirk that makes workers more efficient even though it leaves some willing workers unemployed.<ref>Snowden and Vane (2005), p. 390.</ref>