Citation

Discussion Paper Details

Please find the details for DP10288 in an easy to copy and paste format below:

Full Details   |   Bibliographic Reference

Full Details

Title: A Theory of Wage Adjustment under Loss Aversion

Author(s): Steffen Ahrens, Inske Pirschel and Dennis J. Snower

Publication Date: December 2014

Keyword(s): downward wage sluggishness and loss aversion

Programme Area(s): Labour Economics

Abstract: We present a new theory of wage adjustment, based on worker loss aversion. In line with prospect theory, the workers? perceived utility losses from wage decreases are weighted more heavily than the perceived utility gains from wage increases of equal magnitude. Wage changes are evaluated relative to an endogenous reference wage, which depends on the workers? rational wage expectations from the recent past. By implication, employment responses are more elastic for wage decreases than for wage increases and thus firms face an upward-sloping labor supply curve that is convexly kinked at the workers? reference price. Firms adjust wages flexibly in response to variations in labor demand. The resulting theory of wage adjustment is starkly at variance with past theories. In line with the empirical evidence, we find that (1) wages are completely rigid in response to small labor demand shocks, (2) wages are downward rigid but upward flexible for medium sized labor demand shocks, and (3) wages are relatively downward sluggish for large shocks.

For full details and related downloads, please visit: https://cepr.org/active/publications/discussion_papers/dp.php?dpno=10288

Bibliographic Reference

Ahrens, S, Pirschel, I and Snower, D. 2014. 'A Theory of Wage Adjustment under Loss Aversion'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=10288