The Pure Theory of the Guaranteed Annual Wage Contract

7[THE purpose of this note is to show that the so-called guaranteed annual wage contract establishes a market relationship fundamentally different from that which underlies the conventional wage-rate contract and to indicate the implications of this difference in terms of the pure theory of exchange. To bring out the main line of argument as clearly and as simply as possible we approach the question as a general problem of exchange of two commodities (commodity A and commodity B) between two groups of individuals. Without distorting the central theoretical issue involved, we can further simplify the analysis by assuming that each group consists of essentially identical individuals, that is, individuals with identical preferences in their choice among all the possible combinations of the two commodities and also endowed prior to the establishment of exchange relationships with the other group with the same amount of their particular "stock in trade." These assumptions make it possible to reduce the discussion to a consideration of exchange between two individuals-one representing the "average" member of the first and the other the "average" member of the second group. The average in this instance is strictly identical with any and every other member of the group which he represents, since, whether competing with each other on equal footing or banded together in a single monopoly, they will act in exactly the same way. With the help of conventional Edgeworth-Pareto notation, the basic data of our problem can be depicted by two superimposed sets of indifference lines (see Fig. i). One set with its origin, i.e., its zero point, in a is represented by the curves conforming in their shapes to cfp, while the other with it zero point b consists of lines with opposite curvature similar to that of ceq. The two sets are superimposed in such a way that point c indicates the original position of both representative individuals, the distance ac showing the amount of commodity A in possession of the first and the distance bc indicating the amount of commodity B in the hands of the second. Before the exchange has taken place, the first man has no B and the second does not own any A. The broken curve ct/id is the offer curve of seller (i.e., the original owner) of A. The point h located on this curve shows, for example, that, facing a given "price" of "ck/kh units of A per unit of B" and being free to acquire any amount of B he might wish to buy, the seller of A would buy kh units of B in exchange for ck units of A: In h he reaches a higher indifference curve than in any other point on the given straight price line ch. The broken curve cgdi is the similarly derived offer curve of the seller of B (i.e., the potential buyer of A). If perfect competition prevails on both sides, the resulting exchange will lead to an equilibrium position marked by the intersection point d of the two offer curves. If the sellers of B form a monopolistic combination while competitive conditions prevail among the sellers of A, two different types of market contracts can be distinguished-each one resulting in a different equilibrium situation. Under conditions of the conventional type of marketing, the monopolist is able to set the price and the buyer to determine freely the amount of his purchase. The monopolist-taking into account the reaction of the buyers-obviously establishes that price which leads to an equilibrium position more advantageous to him than any other position corresponding to some