Gift exchange game

The gift-exchange game is a game that has been introduced by Akerlof and Yellen to model labor relations. Two players are at least involved in such game – an employee and an employer. The employer has to decide first, whether to award a higher salary.

Then, the decision of the employee about putting extra effort follows. Like trust games, gift-exchange games are used to study reciprocity for human subject research in social psychology and economics.

If the employer pays extra salary and the employee puts extra effort, then both players are better off than otherwise. The relationship between an investor and an investee has been investigated as the same type of a game.

Equilibrium analysis

The extra effort in gift-exchange games is modeled to be a negative payoff if not compensated by salary. The IKEA effect of own extra work is not considered in the payoff structure of this game. Therefore, this model rather fits labor conditions, which are less meaningful for the employees.

Like in trust games, game-theoretic solution for rational players predicts that employees’ effort will be minimum for one-shot and finitely repeated interactions. Therefore, there is no incentive for the employer to pay a higher salary. If the employer pays a higher salary, it is irrational for the employee to put extra effort, since effort will reduce his or her payoff. It is also irrational for the employee to put extra effort while receiving a lower salary. Therefore, the minimum salary and the minimum effort is the equilibrium of this game.

The payoff matrix of the gift-exchange game has the same structure as the payoff matrix of Prisoner’s dilemma.

Real life usage

The gift exchange model is used to explain workers’ effort and wages provided by firms in the real world, especially involuntary unemployment.

Unlike what is depicted in the simple model above, in real life, employees may exceed the minimum work required and firms may pay more than the market-clearing wage. According to Akerlof’s model, this is because the worker’s effort not only depends on the effort itself, wage rate if employed, and the unemployed benefit if unemployed, but also the norm for effort. Thus, to affect these norms, firms may pay more.