The employment relationship is to a large extent characterized by incomplete contracts, in which workers have a considerable degree of discretion over the choice of their work effort. This discretion at work kicks in the potential importance of “gift exchange” or reciprocity between workers...

This paper models the firm as a community à la Akerlof (1980) to account for asymmetric behavior, and in particular, downward rigidity of wages. It is shown that, through social interaction among workers in the firm community, wage cuts can give rise to a large, discontinuous fall in labor...