Towards a More Complete Efficiency Wage Theory


Address for Correspondence: School of Economics and Finance, K.K. Leung Building, University of Hong Kong, Pokfulam Road, Hong Kong. E-mail: We wish to thank Professor Wing Suen and an anonymous referee for helpful comments and suggestions which contributed tremendously to this paper.


The efficiency wage is an important topic in the theory of employment. In a traditional efficiency wage model, only the representative firm is optimizing against an assumed S-shaped effort supply function. This S-shaped supply curve is critical for the model and the absence of a derivation of the curve in the literature means that it is an incomplete theory. In the present paper, we extend the model by specifying a worker's representative utility function so that the corresponding argmax function will be the S-shaped effort supply curve. This will make the worker's decision process endogenous and will produce a more complete model. The importance of this extension is clear. The characterization of the utility function will make explicit the necessary conditions and crucial assumptions of the traditional model. More importantly, the extension will allow researchers to introduce employment compensation factors into the worker's utility function for analysis. This has important bearings on future development in employment theory. For example, a worker's satisfaction from shirking (net of dismissal risks), or his or her willingness to search for jobs (net of search cost), can now be included in his or her utility function to form an optimal work or search strategy. Incorporating the worker's optimization behaviour into the model will also enable researchers to study policy directed not just towards firms but also towards the worker's decision process. Furthermore, this approach provides a framework for researchers to generate comparative statics. These comparative statics can lead to interesting topics for econometric models or to further research within this field.