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Unemployment and insurance

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  • Rosen, Sherwin

Abstract

This paper elaborates equilibrium properties of contract labor markets when cost barriers limit labor mobility in response to demand and productivity shifts. Unemployment is sustained because the marginal value of labor is not equated across all firms; however the equilibrium contract optimally allocates a worker's time between market and nonmarket uses, given transactions cost-mobility constraints. Contracts provide full unemployment insurance for risks that are diversifiable by pooling among firms. Nondiversifiable (macro) risks are only partially shifted,largely through self-insurance (contingency saving). Increasing diversifiable risk has social value, similar to the value of an option. Increasing nondiversifiable risk has negative value because it reduces lifetime consumption. The main empirical implication of contract theory is shown to be closely related to the permanent income hypothesis and establishes linkages between labor activities and consumption behavior. It is atheory of consumption rigidity rather than wage rigidity. Another empirical implication is that unemployment incidence is proportional to comparative advantage in normarket production. Layoffs are ordered by workers' relative productivity in nonmarket compared with market sectors. The theory is used to analyze some features of the U.S. employment system. Its empirical support is briefly reviewed.

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Bibliographic Info

Article provided by Elsevier in its journal Carnegie-Rochester Conference Series on Public Policy.

Volume (Year): 19 (1983)
Issue (Month): 1 (January)
Pages: 5-49

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Handle: RePEc:eee:crcspp:v:19:y:1983:i::p:5-49

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  1. Hayashi, Fumio, 1982. "The Permanent Income Hypothesis: Estimation and Testing by Instrumental Variables," Journal of Political Economy, University of Chicago Press, vol. 90(5), pages 895-916, October.
  2. V.V. Chari, 1980. "Involuntary Unemployment and Implicit Contracts," Discussion Papers 459, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  3. Hall, Robert E, 1982. "The Importance of Lifetime Jobs in the U.S. Economy," American Economic Review, American Economic Association, vol. 72(4), pages 716-24, September.
  4. Azariadis, Costas, 1975. "Implicit Contracts and Underemployment Equilibria," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1183-1202, December.
  5. John Abowd & Orley Ashenfelter, 1980. "Anticipated Unemployment, Temporary Layoffs and Compensating Wage Differentials," Working Papers 517, Princeton University, Department of Economics, Industrial Relations Section..
  6. Baily, Martin Neil, 1974. "Wages and Employment under Uncertain Demand," Review of Economic Studies, Wiley Blackwell, vol. 41(1), pages 37-50, January.
  7. Diamond, Peter A, 1982. "Aggregate Demand Management in Search Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 90(5), pages 881-94, October.
  8. Robert E. Hall & Edward P. Lazear, 1982. "The Excess Sensitivity of Layoffs and Quits to Demand," NBER Working Papers 0864, National Bureau of Economic Research, Inc.
  9. Robert E. Hall, 1987. "Consumption," NBER Working Papers 2265, National Bureau of Economic Research, Inc.
  10. Grossman, Sanford J & Hart, Oliver D, 1981. "Implicit Contracts, Moral Hazard, and Unemployment," American Economic Review, American Economic Association, vol. 71(2), pages 301-07, May.
  11. Grossman, Herschel I., 1978. "Risk shifting, layoffs, and seniority," Journal of Monetary Economics, Elsevier, vol. 4(4), pages 661-686, November.
  12. Hamermesh, Daniel S, 1982. "Social Insurance and Consumption: An Empirical Inquiry," American Economic Review, American Economic Association, vol. 72(1), pages 101-13, March.
  13. Dale T. Mortensen, 1978. "Specific Capital, Bargaining, and Labor Turnover," Discussion Papers 320, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  14. Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, vol. 2(3), pages 225-243, September.
  15. Lucas, Robert Jr. & Prescott, Edward C., 1974. "Equilibrium search and unemployment," Journal of Economic Theory, Elsevier, vol. 7(2), pages 188-209, February.
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Cited by:
  1. Hans H. Glismann & Klaus Schrader, 2001. "Alternative Systeme der Arbeitslosenversicherung � Das Beispiel der Vereinigten Staaten und des Vereinigten Königreichs," Kiel Working Papers 1032, Kiel Institute for the World Economy.
  2. Robert H. Topel & Finis Welch, 1986. "Efficient Labor Contracts with Employmeny Risk," UCLA Economics Working Papers 399, UCLA Department of Economics.
  3. Abraham, Katharine G & Katz, Lawrence F, 1986. "Cyclical Unemployment: Sectoral Shifts or Aggregate Disturbances?," Journal of Political Economy, University of Chicago Press, vol. 94(3), pages 507-22, June.
  4. Baxter, J. L. & Moosa, I. A., 1996. "The consumption function: A basic needs hypothesis," Journal of Economic Behavior & Organization, Elsevier, vol. 31(1), pages 85-100, October.

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