[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

contract. Although most workers are not covered by formal contracts, wages or
salaries are commonly adjusted only once a year, again contributing to the sluggish
movement of nominal wages.
Henry Ford made headlines in 1914
when he doubled the standard wage for
auto workers in an effort to promote
productivity.
Efficiency Wages Firms want to pay the efficiency wage: that is, the wage that
minimizes their total labor costs. If paying higher wages leads to greater worker productivity,
firms may find that their profits increase when they pay a real wage higher than
the one at which the labor market would clear. When Henry Ford opened his automobile
plant in 1914, he paid his workers $5 per day—a rate more than double the going
wage. The high wage ensured that Ford’s employees worked hard, for they knew
they would have trouble finding another job that paid as well if they were fired.
Henry Ford knew that his new technique of production—the assembly line—when
combined with motivated workers, would increase his profits. The high wage also
reduced turnover of the workforce, because few workers wanted to quit a highpaying
Ford job; and lower turnover saved Ford the cost of training a fresh, inexperienced
worker each time someone with experience left. By boosting productivity and
lowering turnover costs, the high wage paid off for Ford.
Productivity can depend on the wage for several reasons. One has already been
mentioned: above-average wages create an incentive for workers to work hard and
remain with the firm. Moreover, a firm that cuts its wages when demand falls may
so sharply reduce worker morale and labor productivity that its costs of production
actually increase. In addition, when a firm cuts wages, workers are more likely to
quit to look for another job—and as the firm’s labor turnover rate rises, it incurs
increased costs of hiring and training new workers. Compounding the damage, those
most likely to leave in response to a wage cut are a firm’s best, most experienced
workers, whose departure will significantly hurt overall productivity.
Risk and Uncertainty Cutting wages may be a risky strategy for a firm that
wants to reduce its labor force. Whether the wage cut succeeds in encouraging workers
to quit will depend on what other firms do—are they also cutting wages? The
firm may reduce its uncertainty by simply laying off the workers it doesn’t need.
To summarize, when sluggish nominal wages prevent the real wage from adjusting
to maintain labor market equilibrium, shifts in labor demand will result in fluctuations
in cyclical unemployment, as we illustrated in Figure 29.5. Such shifts in
labor demand can occur fairly rapidly, mainly because of changes in output. Wages
fail to fall enough to restore equilibrium (the balance between labor demand and
labor supply) when labor demand shifts downward, resulting in a rise in cyclical
unemployment.
THE SLOW ADJUSTMENT OF PRICES
In the short run, variation in the demand for goods and services has the most effect
on changes in output and, therefore, on the demand for labor. If a firm experiences
a decrease in demand, it can respond by either lowering its price or reducing the
quantity it produces. If a firm experiences an increase in demand, it can respond
by either raising its price or boosting production, since even in economic booms,
646 ∂ CHAPTER 29 INTRODUCTION TO MACROECONOMIC FLUCTUATIONS