What is the difference between labour and capital (as in machinery)? Well, the answer is simple, members of labour have emotions, feelings and a life. They can fall sick and not be able to work, or they can learn and practice and work more efficiently. Therefore, when analyzing labour markets, we must take more things into consideration than just the usual product markets. In assumed perfect competition and a laissez-faire economy, market forces determine the pricing of products. In basic economics, we tend to replicate this system for workers and their wage rates - with the demand for workers being from the employer's side and the supply of workers being from the employee's side. For products, allocating efficiency occurs during market-clearing (when the demand and supply equate); however, is that the same for labour markets? Will the most efficient allocation of jobs be when the demand for labour equates to the supply of labour? According to Carl Shapiro and Joseph Stiglitz, no. A concept known as shirking is important in this. During full employment, there is a very minimal risk of being fired or laid off, and even if that takes place, changing jobs will be simple. Therefore, workers do not put in their optimal effort at work, since they know that they would get the same 'returns' even if their work effort increases; this is known as shirking. Moreover, employers have the disadvantage here, for they are worse off with the information of their employees shirking (since firing them will not be detrimental for them) or even without that information (since the productivity of the employees will be less than the productive efficient levels. What should employers do then? They must impose a cost to the shirking so that employees will have a disincentive to do it. This cost is shown in the graph below [source - Wikipedia]
At full employment level, the supply curve of labour is perfectly inelastic, since the supply of labour is "fixed". As shown in the diagram above, wage W is the initial wage level. However, another curve is also present here, the NSC (no shirking condition) curve. This curve is asymptotic to the full employment level, because at full employment, whatever the wage is, there will still be a level of shirking, due to the simplicity of moving jobs. To produce at the no shirking condition, employers will raise their wages - this is the cost to shirking (losing the extra wage - above equilibrium level - the job provided). What happens though is that all the employers will then follow this, and the equilibrium wage will still be constant, but the wages would have increased and the unemployment would also increase (preventing full employment). This type of unemployment is known as involuntary unemployment which is where the worker is willing and able to work at the given wage also but is denied employment. This shows how the efficient wage model prevents shirking, but introduces a new form of unemployment, preventing "full employment" from emerging.
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