Efficiency Wages and Futures Markets

This paper places the competitive firm a la Sandmo in a standard efficiency wage model, wherein the work effort of labor depends on the wage rate set by the firm. Irrespective of the availability of hedging opportunities, we show that the Solow condition under which the equilibrium effort-wage elasticity equals unity is a norm. Thus, the optimal wage rate paid by the firm is invariant to the risk attitude of the firm and to the incidence of output price uncertainty. We further show that hedging activities induce the firm to hire more labor as a result of the reduction in its risk exposure. Thus, the introduction of futures markets is beneficial in that employment is increased as output is enhanced