In a very helpful blog post, Paul Krugman tries to make sense of Wal-Mart’s recent statement that it is already reaping some gains from raising wages via reduced turnover costs. Krugman’s main point is as follows. If worker productivity is a function of the wage (through improved morale, lower turnover, etc.), and Wal-Mart was initially maximizing profits, then a small change in wages will leave profits largely unchanged.
As Krugman points out, this is logic of the “envelope theorem.” What I want to clarify in this post is that the logic behind this argument is more general than the particular efficiency wage model Krugman works through. Any time firms are choosing wages to balance various concerns—as opposed to simply accepting a “market wage” as a constraint—the logic of the envelope theorem applies. What’s more, two types of empirically relevant models of the labor market—monopsonistic competition and efficiency wages—look pretty similar in this regard, and can be thought of as…
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