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

- Workers form expectations of average wages in decisions about effort and job search.
- Workers' wage expectations are likely to be partly adaptive.
- Partly adaptive expectations may explain why nominal shocks have real effects.
- Results may explain Lucas' (1973) finding about effects of nominal demand shocks.
- Microeconomic parameters determine degree to which expectations are adaptive.

This study develops models in which workers form expectations of average wages in choosing levels of effort and on-the-job search. It is assumed that information on lagged average wages is available at a low fixed cost, whilst acquiring other information requires an additional variable cost. Under reasonable conditions, workers' expectations are at least partly adaptive, and may be a mixture of rational and adaptive expectations. Microeconomic parameters determine the degree to which expectations are adaptive and the weights placed on various lags of wages. As a result of partly adaptive expectations, nominal demand shocks may have real effects.