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Market Failure or Success

The New Debate

Edited by Tyler Cowen and Eric Crampton

Recent years have seen the development of new theories of market failure based on asymmetric information and network effects. According to the new paradigm, we can expect substantial failure in the markets for labor, credit, insurance, software, new technologies and even used cars, to give but a few examples. This volume brings together the key papers on the subject, including classic papers by Joseph Stiglitz, George Akerlof and Paul David. The book provides powerful theoretical and empirical rebuttals challenging the assumptions of these new models and questioning the usual policy conclusions. It goes on to demonstrate how an examination of real markets and careful experimental studies are unable to verify the new theories. New frontiers for research are also suggested.
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Chapter 7: Efficiency wage models of unemployment: one view

H. Lorne Carmichael


H. Lorne Carmichael1 Persistent involuntary unemployment of workers is a recurrent problem in labor markets all over the world. Unemployed workers seem unable to find work even though they are willing to accept lower wages than those being paid employed workers with similar skills. What could be preventing wages from adjusting to clear these markets? Many recent papers, known collectively as the efficiency wage literature, now claim to have the answer. This chapter will survey the efficiency wage literature and critically evaluate some of its accomplishments. Efficiency wage models have already been examined by Yellen (1984), Katz (1986) and Stiglitz (1987), and have received generally favorable reviews. This chapter is more critical. Its overall conclusion is that efficiency wage models provide some useful insights into the workings of the labor market, but they do not provide a satisfactory account of wage rigidity or involuntary unemployment. There are at least five separate versions of ÔtheÕ efficiency wage model. They share a common structure, however, and this is outlined in the first section of the chapter. This section also attempts to relate efficiency wage models to other recent models of unemployment. Section II examines and criticizes the different approaches in detail. Section III evaluates the achievements of this approach and suggests some directions for future work. I. A GENERAL EFFICIENCY WAGE MODEL Efficiency wage models, as the name suggests, are first of all models of wages. They generate unemployment by showing that firms will sometimes want to set wages at non-market clearing...

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