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Wage bargaining and employment

by Ian M McDonald, Robert M Solow
American Economic Review ()

Abstract

A persistent problem of business cycle theory has been the search for a convincing empirical description and theoretical explanation of wage rates during fluctuations in output and employment. A subquestion is addressed that focuses on real wages and asks why fluctuations in the demand for labor should so often lead to large changes in employment and small, unsystematic changes in the real wage. The subquestion is cast in the context of explicit bargaining over wages and employment by a trade union and a firm or group of firms. The methods are entirely partial equilibrium. The approach used is to try out several simple conventions and several formal solutions to the bargaining problem, providing a framework within which they are all seen to bear a family resemblance to one another. The partial-equilibrium bargaining models generally confirm a tendency for fluctuations in real product demand at the firm or industry level to be accompanied by large correlated fluctuations in employment and small changes in real wages that could go in either direction. The source of that tendency is discussed. The main result sharply contrasts with the outcome of standard models of implicit contracting with symmetric information.

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