Habit Preferences


I study wage-setting under worker preferences that feature habit formation or switching costs. Workers may have particularly strong preferences for their current firm and face a utility cost of changing jobs. This could be because workers become friends with their coworkers, or make decisions about things like where to live in conjunction with their choice of job, and then be “locked in” and have much less elastic preferences. This preference will mean that, statically, firms face a less elastic labor supply curve. But dynamically, firms have a greater incentive to raise wages to attract new workers, who will then become habituated to working there.

I find that markdowns of wages relative to marginal product increase from 20% in Card, Cardoso, Heining and Kline (2018) to an average of 22% if workers derive 20% of their job amenities from habit utility (holding total amenities constant). Markdowns increase because, unlike other amenities that are more smoothly distributed across employers, the habit amenity is a point mass, attached to the existing firm and no other. More interesting, however, is the fact that adding habit formation generates equilibrium wage dispersion. I find that steady-state markdowns range from 17% to 27%. This result is similar to Burdett and Mortensen (1998), but derived from switching costs instead of search frictions