Wage differentials in a dynamic theory of the firm

Abstract

The behavior of a profit-maximizing firm in a market characterized by uncertain wage differentials for a homogeneous occupation is studied. The firm must make a number of interdependent decisions at every moment of time. It must choose a wage rate, a level of vacancies and the rate at which it will fill them, and the scale of production. Individual behavior plays an important role in the model. Individuals must decide whether to quit their current job to search for a better position if they are employed and whether to accept any forthcoming offers if they are unemployed. The model is set up as a dynamic optimization problem. The determinants of the firm's relative wage rate are its turnover costs, price of output, the aggregate vacancy-unemployment ratio, and other individual and market variables. It is shown that a firm faced with an excess supply of willing applicants will not lower its wage. This introduces an inflationary bias into the market when changes in the unemployment rate are considered.