Labour Discipline Model

Speaker 1: Imagine you're part of the senior management team at Brenda, Inc., a marketing agency, to bring a breath of fresh air into the company. You want to hire someone young? Out of all the inexperienced candidates you choose, Maria, the profile fits the job well. But before you offer Maria the job, you need to decide on the salary. But what do you pay a young, inexperienced graduate as a starting salary? You have an idea. First you look at how much unemployment benefit is, and then you just pay Maria a little more. Let's say 650 per hour. That is still better than not working at all and receiving unemployment benefit. Let's say Maria accepts the job and the salary offer. After a short time, however, you realize that Maria's performance is far from satisfactory. You are, of course, upset and confront her. After all, both of you did sign an employment contract. But unlike sales contracts, which specify exactly who gets what service or goods for what price. Employment contracts are incomplete. This is because they cannot specify how much effort employees should put in or how motivated they should be while working. This information is not visible to you and therefore not verifiable. You would therefore have no legal recourse. However, when you talk to her, Maria admits that she's only working for Brenda Inc. and that she's not intrinsically motivated to do this, and she justifies her effort with a simple calculation. The difference between her wage and the next best alternative unemployment benefit is so small that it's not really worth it for her to work harder. This difference is called the employment rent. The lower the employment rent, the less you stand to lose. If, for example, you are laid off. She's right, of course. And you ask her how much you would have to pay her to improve her performance. Speaker 2: Using a curve called the best response function. I can show you how hard I will work at what hourly wage. My work effort depends on my next best alternative, the unemployment benefit. This is my reservation wage and determines the starting point of the curve. If I expect to be unemployed for a long time, my best response function tends to be steep. If I expect to be unemployed for a short time, the curve tends to be flat. Let us assume an unemployment benefit of €6 per hour and an expected duration of unemployment of 44 weeks. At a low wage, my best response function is steep. A small wage increase raises my labour input by a considerable amount at higher wages. However, wage increases have a smaller effect on my input. Speaker 1: This is best illustrated by an example. Imagine that Maria's effort is measured between 0 and 1, and shows what proportion of a working hour she works productively. If our effort is zero, she's not working productively and is just surfing the internet. If she's not working productively at all, ten minutes of productive work is not very hard because she still has 50 minutes of break time. Therefore, the best response function for low effort and low pay is steep. Additional effort is easy. However, if she already works very productively for 55 minutes out of an hour, additional effort is hard. For example, without a short break, her concentration will eventually drop. Therefore, the curve is rather flat at high effort and high wage. Here, you can see that paying higher wages can lead to higher labor input, but with diminishing marginal returns, that is, the higher the initial wage, the smaller the increase in effort and output that Brenda Inc would achieve by paying an additional euro per hour. Like you, every business tries to get the most out of its workforce at the lowest possible cost, in other words, to produce as cheaply as possible. Paying Maria 650 per hour hasn't worked so well, as you know. But to make her work hard, you would have to pay her a very high wage. Maria will then produce a lot, but the cost of her labor will be so high that it will not be worth it. An optimal relationship between costs and labor input. You need isoquant lines for Maria's effort input. These are straight lines that represent all combinations where Maria's labor input costs the same. The steeper the line, the lower the wage costs, and the lower the wage that has to be paid for the same labor input. To calculate the slope, you need the hourly wage w Maria's effort. E that is the units of work that Maria would do in an hour, which corresponds to her effort. You get the slope of the line by dividing E by W. The cost of a whole unit of work is obtained by dividing w by e. For example, suppose you pay a wage of W is €10 and Maria's effort level is equal to 0.45. This gives you a slope of 0.045 and a cost per unit of effort of €22.22. Along this line, you will always have the same cost per unit of effort at any point. Since it is impossible to specify Maria's level of effort, you simply take her best response function and find the ISO cost line tangent to her curve. In her case, this is done at an hourly wage of €12, for which Maria exerts an effort of 0.5. Incidentally, the combination of Maria's best response function and the company's ISO coastline is called the labor discipline model. An hourly wage of €12. Sounds good to Maria. She now receives twice as much as she would have received on unemployment benefit, and since she now has something to lose, namely her employment rent, she works harder. And you are happy because for the minimum realizable wage, you can expect sufficient labour input to maximise your profits.