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Equilibrium Wage And Employment Dynamics In A Model Of Wage Posting Without Commitment

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Executive Summary

A rich but tractable variant of the Burdett-Mortensen model of wage setting behavior is formulated and a dynamic market equilibrium solution to the model is defined and characterized. In the model, firms cannot commit to wage contracts. Instead, the Markov perfect equilibrium to the wage setting game, characterized by Coles (2001), is assumed. In addition, firm recruiting decisions, firm entry and exit, and transitory firm productivity shocks are incorporated into the model. Given that the cost of recruiting workers is proportional to firm employment, the authors establish the existence of an equilibrium solution to the model in which wages are not contingent on firm size but more productive employers always pay higher wages.

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