The auction and search theories do not imply that firms will
hire quantities of labour for which the value marginal product
is unequal to the nominal wage rate. The contract theory, on
the other hand, contains a strong presumption that the value
marginal product of labour will not equal the nominal wage rate.
True or False?
The statement is true. Under the auction theory wages adjust
immediately to changes in the demand for labour with workers
working more when wage rates are perceived as above normal
levels and less when wage rates are thought to be below normal.
Under the search theory, firms employ additional workers, if
possible, whenever expanded employment will increase current
profits---that is, whenever wage rates are below the value marginal product
of labour---and employ fewer workers when the opposite is true.
Under the contract theory, firms forgo the maximization of
short-run profits in order to maximize long-run profits. This
will mean that the value marginal product of labour will in
general not equal the wage rate currently being paid.
There is no particular requirement that the firm vary
employment to equalize the value marginal product of labour, given
by the vertical distance between the demand curve for labour and
the horizontal axis, and the wage rate. The firm is supplying its
workers with income stability that increases with seniority in
order to induce them to accept lower average wages. This goal is
not necessarily accomplished by strict period-to-period maximization
of profits. The owners of the firm are interested in maximizing its
present value or, in other words, its long-run profits.
Return to Lesson