Template-Type: ReDIF-Paper 1.0
Author-Name: Steffen Ahrens
Author-X-Name-First: Steffen 
Author-X-Name-Last:  Ahrens
Author-Name: Inske Pirschel
Author-X-Name-First: Inske 
Author-X-Name-Last: Pirschel
Author-Name: Dennis J. Snower
Author-X-Name-First: Dennis J. 
Author-X-Name-Last: Snower
Author-Name:
Author-X-Name-First: 
Author-X-Name-Last: 
Title: A Theory of Wage Adjustment under Loss Aversion
Abstract: We present a new theory of wage adjustment, based on worker loss
aversion. In line with prospect theory, the workers’perceived utility losses
from wage decreases are weighted more heavily than the perceived utility
gains from wage increases of equal magnitude. Wage changes are eval-
uated relative to an endogenous reference wage, which depends on the
workers’rational wage expectations from the recent past. By implication,
employment responses are more elastic for wage decreases than for wage
increases and thus …rms face an upward-sloping labor supply curve that
is convexly kinked at the workers’ reference price. Firms adjust wages
‡exibly in response to variations in labor demand. The resulting theory
of wage adjustment is starkly at variance with past theories. In line with
the empirical evidence, we …nd that (1) wages are completely rigid in re-
sponse to small labor demand shocks, (2) wages are downward rigid but
upward ‡exible for medium sized labor demand shocks, and (3) wages are
relatively downward sluggish for large shocks.
Length: 26 pages
Creation-Date:  2014-12
File-URL: http://sfb649.wiwi.hu-berlin.de/papers/pdf/SFB649DP2014-071.pdf
File-Format: Application/pdf
Number: SFB649DP2014-071
Classification-JEL: D03, D21, E24
Keywords: downward wage sluggishness, loss aversion
Handle: RePEc:hum:wpaper:SFB649DP2014-071