10. Work and Wages

This chapter introduces the modern theory of the firm and labor markets, by an ironic twist in the history of economics, finding its origins in the works of Ronald Coase and Karl Marx. It positions the employment contract as incomplete, specifying hours and wages but not how hard the worker works, a key distinction from Walrasian models where productive services (including labor effort|) are exchanged directly. This incompleteness introduces fundamental changes to market dynamics.

In a perfectly competitive Nash equilibrium of the labor discipline model introduced here, the labor market does not clear, and the wage rate, worker effort, work hours, and working conditions are both technically- and Pareto-inefficient. This does not occur due to “sticky nominal wages” or any other ad hoc assumptions, but instead to the incompleteness of the labor contract. In this model, the employer exercises power over the worker, and social norms, including reciprocity and inequality aversion, affect wage setting and worker effort. This framework provides an analytical link to macroeconomic outcomes like involuntary unemployment and addresses policy issues such as monopsony and the minimum wage.