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Oxford Economic Papers Advance Access originally published online on June 9, 2008
Oxford Economic Papers 2009 61(3):494-516; doi:10.1093/oep/gpn018
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© Oxford University Press 2008 All rights reserved

A theory of efficiency wage with multiple unemployment equilibria: how a higher minimum wage law can curb unemployment

Kaushik Basu* and Amanda J. Felkey{dagger}

*Department of Economics, Cornell University, Ithaca, NY 14850, USA; e-mail: kb40{at}cornell.edu
{dagger}Department of Economics, Lake Forest College, Lake Forest, IL 60045, USA; e-mail: felkey{at}lakeforest.edu

JEL classifications: J60, O12, D40


  Abstract

This paper uses efficiency wage theory and the existence of community-based sharing to hypothesize that labor markets in developing countries have multiple equilibria—the same economy can be stuck at different levels of unemployment with different levels of wages. The model is meant for developing economies where wage-productivity links are discernible and income-sharing among the poor is prevalent. It seems reasonable to posit that in such an economy more unemployment leads to more income sharing. The main results are generated combining this claim with a theoretical demonstration of the fact that more sharing increases unemployment rates. As corollaries, we show that (1) within the same society, two different racial groups that may be ex ante identical can have different levels of unemployment and wages in equilibrium and (2) the imposition of a legal minimum wage can raise employment.


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