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Efficient Labor Contracts with Employmeny Risk

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  • Robert H. Topel

    (UCLA)

  • Finis Welch

    (UCLA)

Abstract

This article analyzes efficient employment agreements where the demand for consumption insurance can be satisfied by noncontractual means. We assume that workers can save and that consumption is determined by a strong form of the permanent income hypothesis. Under conditions of asymmetric information about exogenous shocks to labor demand, we derive a unique compensation schedule that efficiently guides decisions by both workers and employers. Efficient employment outcomes are generated without a need for third-party enforcement or monitoring, and workers choose a consumption policy that leaves them indifferent among realizations of labor demand. Within this solution it is both costless and efficient for workers to delegate employment decisions to the firm. Within the context of the model we analyze implications for the equilibrium distribution of wages and for empirical studies of labor supply.

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Bibliographic Info

Paper provided by UCLA Department of Economics in its series UCLA Economics Working Papers with number 399.

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Date of creation: 01 May 1986
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Handle: RePEc:cla:uclawp:399

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Web page: http://www.econ.ucla.edu/

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  1. Altonji, Joseph G, 1982. "The Intertemporal Substitution Model of Labour Market Fluctuations: An Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 49(5), pages 783-824, Special I.
  2. Milton Friedman, 1957. "A Theory of the Consumption Function," NBER Books, National Bureau of Economic Research, Inc, number frie57-1, July.
  3. Flavin, Marjorie A, 1981. "The Adjustment of Consumption to Changing Expectations about Future Income," Journal of Political Economy, University of Chicago Press, vol. 89(5), pages 974-1009, October.
  4. Bengt Holmstrom, 1980. "Contractural Models of the Labor Market," Discussion Papers 442, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  5. Kahn, Charles M. & Green, Jerry, 1983. "Wage-Employment Contracts," Scholarly Articles 3203642, Harvard University Department of Economics.
  6. Grossman, Michael, 1973. "Unemployment and Consumption: Note," American Economic Review, American Economic Association, vol. 63(1), pages 208-13, March.
  7. Hall, Robert E, 1978. "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 971-87, December.
  8. Heckman, James J, 1974. "Life Cycle Consumption and Labor Supply: An Explanation of the Relationship Between Income and Consumption Over the Life Cycle," American Economic Review, American Economic Association, vol. 64(1), pages 188-94, March.
  9. MaCurdy, Thomas E, 1981. "An Empirical Model of Labor Supply in a Life-Cycle Setting," Journal of Political Economy, University of Chicago Press, vol. 89(6), pages 1059-85, December.
  10. Baily, Martin Neil, 1974. "Wages and Employment under Uncertain Demand," Review of Economic Studies, Wiley Blackwell, vol. 41(1), pages 37-50, January.
  11. Yaari, Menahem E., 1976. "A law of large numbers in the theory of consumer's choice under uncertainty," Journal of Economic Theory, Elsevier, vol. 12(2), pages 202-217, April.
  12. Lucas, Robert E, Jr & Rapping, Leonard A, 1969. "Real Wages, Employment, and Inflation," Journal of Political Economy, University of Chicago Press, vol. 77(5), pages 721-54, Sept./Oct.
  13. Rosen, Sherwin, 1983. "Unemployment and insurance," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 19(1), pages 5-49, January.
  14. Hamermesh, Daniel S, 1982. "Social Insurance and Consumption: An Empirical Inquiry," American Economic Review, American Economic Association, vol. 72(1), pages 101-13, March.
  15. Bewley, Truman, 1977. "The permanent income hypothesis: A theoretical formulation," Journal of Economic Theory, Elsevier, vol. 16(2), pages 252-292, December.
  16. 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.
  17. Gordon, Donald F, 1974. "A Neo-Classical Theory of Keynesian Unemployment," Economic Inquiry, Western Economic Association International, vol. 12(4), pages 431-59, December.
  18. Hart, Oliver D, 1983. "Optimal Labour Contracts under Asymmetric Information: An Introduction," Review of Economic Studies, Wiley Blackwell, vol. 50(1), pages 3-35, January.
  19. Akerlof, George A & Main, Brian G M, 1981. "An Experience-Weighted Measure of Employment and Unemployment Durations," American Economic Review, American Economic Association, vol. 71(5), pages 1003-11, December.
  20. Azariadis, Costas, 1975. "Implicit Contracts and Underemployment Equilibria," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1183-1202, December.
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Cited by:
  1. Kevin M. Murphy & Robert H. Topel, 2006. "The Value of Health and Longevity," Journal of Political Economy, University of Chicago Press, vol. 114(5), pages 871-904, October.
  2. Abigail S. Hornstein & James Hounsell, 2013. "Managerial Investment in Mutual Funds," Wesleyan Economics Working Papers 2013-005, Wesleyan University, Department of Economics.

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