does fairness prevent market clearing
TRANSCRIPT
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Does Fairness Prevent MarketClearing? : An Experimental
Investigation By Fehr, Kirchsteiger
and Riedl (1993)
Presented By Preetha Rajan
Econ 776Experimental Economics
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The Aim
The aim of this paper by Fehr etal. was to test in the context of a
competitive experimental market,the validity of the fair-wage effort
hypothesis.
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The Fair Wage - Effort Hypothesis
The postulates of the fair-wage hypothesis, as put-forthby Akerlof (1982) and Akerlof and Yellen (1988, 1990)are:
• The fairness oriented behaviour of workers may lead to
involuntary unemployment.• There exists a positive relationship between work
effort and wages. Because of this relationship, it maybe profitable for employers to pay wages above themarket-clearing level.
• Further, wage increases raise workers’ effort levelseven in the absence of any increase in the penalty forshirking.
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The Design of the Experiment
The experiment consisted of two stagesconstituting one period. Twelve periods in eachsession. Four sessions in total.
Before each session, all subjects picked a card – card with S - worker, card with B - employer.
First stage was a one sided oral auction withemployers as bidders, making wage proposals
with no opportunity to choose the worker withwhom they traded, since every worker couldaccept every offer. Stage one ended if the workeraccepted an offered wage p, concluding a binding
contract with the employer
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Continued
The second stage involved workers choosingtheir effort with their choice being revealed
only to the employer. There were no sanctions
associated with this choice.
Workers and employers were located in
different rooms. The transmission of wage
price and effort levels took place through
telephone. Wage price messages were public
knowledge. The effort choices were coded and
known only to the two parties involved.
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Continued Monetary effort costs for workers – given by
increasing function m=m(e), m(emin)=0
emin is the minimum effort level with zero effortcosts. The m(e) schedule is the same for allworkers.
u j = p j-c-m(e j) is the total monetary pay-off ofworker j with wage p j, effort level e j andmonetary cost of providing one unit of labourtime c
πi = (υ-pi)ei is the payoff of employer i whoseworker chose effort ei. The expression υei is suchthat one unit of effort produces υ units of outputwhich is sold for a price of one.
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Hypotheses used to test the fair wage-
effort hypothesis
Hypothesis one: Effort level is increasing in thewage.
Hypothesis one is tested by fitting a regressione= α + β.p +μ – hypothesis not rejected if β is greater
than zero To account for behavioural differences among
workers with regard to the fairness notion, dummyvariables di are used for workers to run the followingregression : e= Σγidi + βp + μ - Wald statistic is usedto test the null hypothesis (pertaining to testing thesignificance of behavioural differences of workers)that all estimated γi are equal to the estimated α co-efficient
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Continued
Period Dummy variables pt added to account forthe possibility that effort varies systematicallyacross periods – takes a value 1 if relevant
observation made in period t and value zero ifotherwise. The following regression equation isrun - e= Σθtpt + βp + μ – Wald statistic is used totest the null hypothesis that all θt are equal to the
estimated α co-efficient Hypothesis two states that the average wages in
the experiment are considerably greater than themarket clearing wage
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Continued
Hypothesis 2 tested using variable “r”, which
is the “average relative overpayment” -
r = (p0 – c – τ)/ (υ-c) – hypothesis 2 is true if r
is considerably greater than zero and has no
tendency to converge to zero
Hypothesis three states that the average
effort per period is above emin
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Experimental Results
Experimental Results rather favourable forthe fair wage-effort hypothesis
The average relative overpayment was 0.42 –
employers gave workers 42% of surplus – despite there being more workers than jobs
The average effort chosen by workers was 0.4
- this was 4 times the level predicted bystandard theory
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Continued
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Continued
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Continued
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Continued
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Interpretations and Conclusions
Employers on making wage offers took intoaccount that effort level of workers dependedon the wage
Employers’ hope that fairness considerationsinduce workers to choose a high effort inresponse to high wages has been justified
Reputation formation is unlikely to be a
driving force behind deviation from standardprediction
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