ABSTRACT
To start the analysis we need to identify three groups in an economy: (1) the owners of firms, (2) those individuals who currently have a job, and (3) those persons who have decided to participate in the labor market but are currently unemployed. Firms will be treated as identical, making the “representative” firm’s welfare the appropriate measure of its approval or disapproval of any proposed change.1 However, individuals who supply labor differ in two respects: (1) their reservation wage and (2) the likelihood of losing their job based on the “security” of their employment. The first characteristic determines the amount of rent a worker receives from employment; the lower is the reservation wage relative to the actual wage the larger is the rent component of wage income. Although certain factors such as nonwage income can help to determine a person’s reservation wage, it remains virtually unobservable and most labor-force participants probably would not reveal their reservation wage if asked by a poll taker, for example. Security of employment, on the other hand, is likely to be determined to a large extent by seniority with a firm. Most explicit union contracts in the United States have lay-off clauses based on “last-in-first-out”. Even in nonunion settings, firms often lay-off the least experienced workers. More recently however, particularly in the 1982 and 1991 recessions, whole plants have closed their doors and even the most senior workers have lost their jobs, although they usually get severance packages that are geared to years of employment.
