We propose a dynamic duopoly game where firms choose the amount of labour to employ at each point in time under the assumption that wages do not adjust instantaneously to the level indicated by the labour supply. Our analysis is conducted in terms of a differential game. We derive open-loop and closed-loop (feedback) Nash equilibrium strategies and show how wage stickiness impacts on firms' labour demand and the long-run equilibrium wage. We also characterize the social optimum, and show how the government can induce firms to behave in a way that is socially desirable through labour income taxation.
Group for Research in Decision Analysis