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Institutions and Wage Formation in the New Europe

Edited by Gabriel Fagan, Francesco Paolo Mongelli and Julian Morgan

Institutions and Wage Formation in the New Europe addresses the role played by institutions in European wage formation with a focus on EMU and institutional change in labour markets.
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Chapter 2: What determines the reservation wages of unemployed workers? New evidence from German micro data

Eswar S. Prasad


Eswar S. Prasad* INTRODUCTION The reservation wage is an important concept for modelling certain key aspects of labour market dynamics. In particular the theory of optimal job search typically implies the reservation wage property in the context of structural models of job search behaviour. The reservation wage is also a concept that has relevance for modelling labour supply decisions, through its influence on transitions from non-employment to employment. Understanding the factors, both microeconomic and macroeconomic, that influence the reservation wage is therefore of considerable importance from both analytical and policy perspectives. In this chapter I provide an empirical analysis of the determinants of reservation wages using individual data from the German Socio-Economic Panel (GSOEP). One of the questions included in the survey explicitly asks unemployed workers what wage rate would have to be offered in order for them to consider accepting a job, that is, their reservation wage. In addition, the GSOEP is particularly well suited to the analysis of reservation wages since it includes a rich set of individual- and household-specific characteristics. In this chapter I also exploit another strength of the GSOEP, which is the availability in each survey wave of detailed retrospective information on employment and income histories for individual workers. For the purposes of analysing reservation wages, this data set is unique in that the longitudinal aspect enables direct comparisons of reservation wages with accepted wages in future periods and can also be used to examine changes in reservation wages over time. Earlier studies of reservation...

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