Efficiency Wages: Combining the Shirking and Turnover Cost Models

This short paper attempts to combine the shirking and turnover cost models into a composite model that captures the main features of each. Our main result is that in equilibrium, the elasticity of effort with respect to the wage will equal the elasticity of the average cost of labour with respect to the wage. This is a generalisation of earlier models since this condition simplifies to the familar Solow Condition if turnover is independent of the wage and simplifies to the condition that the wage is chosen to minimise the average cost of labour if shirking effects are absent. We provide an example that shows how the shirking and turnover cost models are complements rather than substitutes, since the impact on wages of one type of efficiency wage effect is stronger when the other type of efficiency wage effect is also present.