Scandinavian Working Papers in Economics

Research Papers in Economics,
Stockholm University, Department of Economics

No 1999:13: Reciprocity and Wage Undercutting

Martin Dufwenberg ()
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Martin Dufwenberg: Dept. of Economics, Stockholm University, Postal: Department of Economics, Stockholm University, S-106 91 Stockholm, Sweden

Abstract: It is well-documented that employers refuse to hire workers who offer their services at less than the prevailing wage. The received explanation is that workers are motivated by reciprocity¾ they desire to reward kindness and punish hostility. To refuse an outsider’s under-bid is viewed as a kind choice that is met with good effort; a low wage is viewed as an insult that is met with shirking. We have developed a general theory of reciprocity which in this paper is applied to a wage-setting game played by an employer and two workers. We show that when workers are motivated by reciprocity, equilibrium behaviour accords well with the aforementioned stylized facts.

Keywords: Reciprocity; wage underbidding; unemployment

JEL-codes: D63; E24; J41

17 pages, November 4, 1999

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