This post and the two that follow elaborate on last week’s essay. They provide a more rigorous summary of GEM modeling that is rooted in the extension of rational price-mediated exchange from the marketplace to workplaces restricted by asymmetric information and routinized jobs. The summary is divided into three parts: defining the theory’s two venues of optimizing exchange organized by general decision-rule equilibrium, outlining continuous-equilibrium employment, and explaining rational venue interaction.

*Two venues.* Building on fundamental heterogeneities (in decision rules, constraints, and mechanisms of exchange), workplace exchange in the unbundled large-establishment and bundled small-firm venues has been derived from axiomatic preferences and technology:

Ź_{J}(t)=ƒ(W_{J}(t),W^{n}_{J}(t),Ź^{ɱ}_{J}), s.t. if W_{J}(t) ∈ [W^{n}_{J}(t),W^{m}(t)], (ΔŹ_{J}(t)/Ź^{n}_{J}(t))/ (ΔW_{J}(t)/W^{n}_{J}(t))** >**1.

Truly axiomatic assumptions governing the large-establishment venue (LEV) must recognize both the strong preference for fair treatment, especially in a corporate hierarchy of authority, and the asymmetric information characteristic of large, complex workplaces. Axiomatic assumptions are a great improvement over the arbitrary assumptions of convenience used in mainstream coherent modeling. In a 1996 interview with John Cassidy (2010, p.192), Robert Lucas admitted that: “I write down a bunch of equations, and I say this equation has to do with people’s preferences and this equation is a description of the technology. But that doesn’t make it so. Maybe I’m right, maybe I’m wrong. That has to be a matter of evidence.” Had Lucas not skipped the critical step of making sure that his assumptions about preferences and technology were axiomatic, his models could have been stabilization-policy relevant as well as coherent and in continuous equilibrium. Maybe his modesty a year after accepting the Nobel Prize was a hint the policymakers should take his macroeconomics too seriously.

The small-establishment venue is market-centric and therefore more familiar to macro theorists:

Ź_{K}(t)=Ź^{ɱ}_{K} and W_{K}(t)=W^{m}(t), s.t. if W_{K}(t)>W^{m}(t), (ΔŹ_{K}(t)/Ź^{ɱ}_{K})/(ΔW_{K}(t)/W^{m}(t))** <**1.

Recall that, if *W*_{j}>*W*^{n}_{j}, then (ΔŹ_{j}/Ź^{n}_{j})/(Δ*W*_{j}/*W*^{n}_{j})** =**0. The notation is explained in the website’s Glossary.

Exchange generalization has powerful implications. LEV labor pricing occurs only in the workplace; SEV wages default to the marketplace. The two venues are combined into a continuous-equilibrium framework that microfounds meaningful wage rigidity (MWR), good-job rationing, and consequential meta-externalities resulting from a range of nominal-demand disturbances.

LEV equilibrium features unbundled exchange, resulting from the simultaneous optimization of employer labor pricing and employee on-the-job behavior at *W*_{J}(t)=*W*^{n}_{J}(t)=max(*Ź*_{J}(t)/*W*_{J}(t))= sup **Ҝ**_{J}(t)>*W*^{m}(t) and *Ź*_{J}(t)=*Ź*^{n}_{J}(t). Workplace macrodynamics are rooted in employees’ inter-temporal calibration of their reference standards (**Ҝ**_{J}(t)), a process governed by rational substitution of consumption for equitable treatment by employers. (Recall that, for convenience, employees are posited always to prefer consumption to equitable treatment.) The tradeoff is informed by production-capability decisions motivated by rational profit expectations, reducing the role of interest rates relative to mainstream modeling.

Pure profits (*Π*_{J}), the income-distribution residual claimed by owners of sunk capital, are restored to the central role they played in classical thinking. Generalized-exchange modeling is then able to assign, as needed, coherent roles to increasing returns, proprietary technological innovations, wage cartelization, product-pricing power, the hold-up problem, and fluctuations in nominal demand. Enriched profit dynamics imply a strong tendency for employee reference standards (**Ҝ**_{J}) to be durable, always unchanged in response to business cycles and not unreasonably unchanged deep into the medium term. (Chapters 2 and 3) The efficiency wage (*W*^{n}_{J}), chronically exceeding labor opportunity costs, pushes workers off their market-supply schedule. Rational work-leisure substitution is suppressed, restricting LEV employee choice to optimizing his or her OJB.

Meanwhile, SEV employers effectively monitor workplace behavior, bundling their Workplace-Exchange Relations (WER). Labor pricing is optimized at *W*_{K}(t)=*W*^{m}(t) and labor behavior at *Ź*_{K}(t)=*Ź*^{ɱ}_{K}. Firms and workers can do no better than being market-price takers. Employees do not experience the workplace information imperfections needed for the spontaneous establishment of interpersonal/intertemporal reference standards. **Ҝ**_{K} is truncated (**Ҝ**_{K}(t)={*W*^{a}(t)}, sup **Ҝ**_{K}(t)= *W*^{a}(t)=*W*^{m}(t)), and rational workers optimize work-leisure choice as well as their ongoing search for good (rent-receiving) employment.

Blog Type: Wonkish Chicago, Illinois

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