The formation of wage expectations in the effort and quit decisions of workers

While much work in macroeconomics considers the formation of price expectations, there has been relatively little work analyzing wage expectations. This study develops models in which workers form expectations of average wages in choosing levels of effort and on-the-job search, under the assumption that information on lagged average wages is free but other information is costly. Under reasonable conditions, workers’ expectations are likely to be at least partly adaptive. It is argued that wage expectations may be more important than price expectations in explaining unemployment fluctuations.