There is a large number N of identical competitive firms.

The representative firm maximises profits: = Y wL, where Y is output, L is labour and w is wage.

The firm's output is given by Y = F(eL), where e is effort. Note that the production function satisfies F () > 0, F ()

The effort depends on the wage w offered to the worker, the average wage paid in the market, wa, and the unemployment rate,

W-x ) B e = e(w, Wa, u) = if w > x otherwise where x = (1 - bu) wa, 0 0