Let's say an employee, Mike in Indiana, earns \$10.50 an hour. He gets a raise to \$13, but because he is no longer eligible for SNAP (food stamps), his net earnings actually go down. His wage has passed a certain eligibility criterion, and as a result there's a drop-off in benefits he's entitled to, and net income as a result. We call the situations that lead to these scenarios cliff effects, and a few examples as apply to Mike are shown in the graph below.

Cliff effects graph

What I'm curious about is a rather specific question owing to the existence of cliff effects. Employees typically don't track earnings by employee after accounting for cliff effects, and so, what is the effect of their ignorance on the economics of the labor market? How does inability of employers to know about cliff effects experienced by their employees affect the market?


There is generally no effect of employers not formally tracking their employees' subsidies on the labor market. Generally speaking government subsidy is already reflected in the labor market whether employers know about it or not.

A trivial example would be policy that gives unemployed people benefits as long as they are unemployed (let's say ${\\\$}100$). Employees only accept job if the benefits of having job outweigh the costs of having it. Simplifying by assuming that only benefit of job is the money and nothing else (unrealistic but does not affect underlaying mechanism) in the above scenario employee won't accept any job offer that does not pay at least ${\\\$}100$.

So in this case whether employer knows about the subsidy or not job will be created only if employer is prepared to bid for the job more than ${\\\$}100$ and only jobs that pay more then ${\\\$}100$ will be created in the economy. Really the only difference between scenario where employer knows about subsidy or don't is that those employers who don't know will wonder about employees rationale for asking ${\\\$}100$ but that has no additional effect on labor market. Employer has no reason to care about whether the ${\\\$}100$ is being asked because that is the employee's value of free time so employee won't accept less or whether this is because of another competing job offer or government subsidy. This the beauty of price system - you don't need to understand people's motivations or preferences or situation - they will already be reflected in prices they are willing to pay or they ask for (in symmetrical fashion some businesses also get subsidies from government that can be conditional on their size/profitability (e.g. some credit for small businesses) -these could affect labor market but are not dependent on employees actually knowing about these subsidies).

The above generalizes to the situations when subsidies depend on the wage as in your description above. Again such subsidies would have effect on employment/wage or other factors, but generally the employer knowledge of those subsidies would not.

  • 2
    $\begingroup$ It can get more complicated than that: if the pattern is as illustrated in the chart, the employer may observe that there are substantially fewer women applying to work at $\$16-17$ an hour than at $\$13-14$ an hour but not know about the childcare issue. If these are the employer's two wage bands (supervisory and basic workers) there may be a worry about sex discrimination. $\endgroup$
    – Henry
    Nov 13 '20 at 13:05
  • $\begingroup$ @Henry that’s actually nice observation. I did not consider that. However, it would also not change the mechanism if the employers would want to let’s say virtue signal they would be affected whether they know if this is due to objective reasons not discrimination. But I suppose in some game where owners hire managers and worry about their discrimination this could make some difference. $\endgroup$
    – 1muflon1
    Nov 13 '20 at 13:14
  • $\begingroup$ This answer covers the situation in which pay is static, but I'm not sure it applies once you allow raises (and "lowers", though with downward-sticky wages, clearly rare). What about the effects when, for example, an employee gets a raise to above the eligibility criterion for medicaid, and as a result the employee starts searching for alternative employment, as she can no longer afford to pay for healthcare? Or the cases in which, and this might be the more important scenario, an employee falls off the cliff, and then changes occur which aren't obvious to the market, like morale dropping? $\endgroup$ Nov 13 '20 at 14:52
  • $\begingroup$ @TheEnvironmentalist but I am not denying these subsidies do have real economic effects. But note that is not the question you asked (or maybe you meant to ask that but you did not). You asked about what is the effect of employer ignorance about this subsidy. Sure the employee might start looking for alternative employment and that will affect wage negotiations/employment at a firm - but the employer does not need to know about subsidy being the reason for this for all this to happen. Employer can be completely ignorant of the subsidy and it will still have effects it does $\endgroup$
    – 1muflon1
    Nov 13 '20 at 14:55
  • 1
    $\begingroup$ @TheEnvironmentalist maybe this will more understandable with analogy. For example, when it comes to consumer market we know that for typical demand curve increase in price leads to (ceteris paribus) lower quantity demanded. Well price can increase for multiple different reasons it might be due to taxes/tariffs/increase in costs. This increase in price will have real effect on quantity demanded but knowledge of why it increased does not matter. Is there any difference from consumer perspective of knowing that the price increased because of this or that tax/tariff? $\endgroup$
    – 1muflon1
    Nov 13 '20 at 15:08

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