Introduction

We now expose the simple models of urban efficiency wages. As in Chapter 1, we propose a model where housing prices and workers' location (land market), as well as wages and unemployment (labor market) are determined in equilibrium. This chapter constitutes the benchmark model of the urban efficiency wage theory we first developed in Section 2. In this simple model where workers' relocation is costless, the efficiency wage set by firms has two roles: to prevent shirking (incentive component) and ensure that workers are locationally indifferent (spatial compensation component). Indeed, as in the benchmark urban search model of Chapter 1, wages increase with commuting costs because firms need to compensate their employed workers for the additional commuting costs incurred when they leave unemployment. The land market and the labor market interact with each other since both wages and unemployment depend on commuting costs, and housing prices as well as location are, in turn, affected by workers' wages. In particular, we find that when the unemployment benefit increases, labor demand decreases and thus, the employment zone is reduced. This, in turn, increases the instantaneous utility of the employed workers and thus, the employed reduce their bid-rent, which decreases land prices in the city.

In Section 3, we introduce endogenous housing consumption and see how the results of the benchmark model are affected. We find that the urban efficiency wage is still positively affected by commuting costs because of the spatial compensation firms need to provide to their employed workers. The interesting aspect of this model is that city size is endogenous and depends on both the total number of workers and housing lot sizes.