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Consumption Commitments and Employment Contracts

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  • Andrew Postlewaite

    ()
    (Department of Economics, University of Pennsylvania)

  • Larry Samuelson

    ()
    (Department of Economics, University of Wisconsin-Madison)

  • Dan Silverman

    ()
    (Department of Economics, University of Michigan)

Abstract

We examine an economy in which the cost of consuming some goods can be reduced by making commitments that reduce flexibility. We show that such consumption commitments can induce consumers with risk-neutral underlying utility functions to be risk averse over small variations in income, but sometimes to seek risk over large variations. As a result, optimal employment contracts will smooth wages conditional on being employed, but may incorporate a possibility of unemployment.

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Bibliographic Info

Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 06-028.

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Length: 31 pages
Date of creation: 14 Jan 2006
Date of revision: 07 Dec 2006
Handle: RePEc:pen:papers:06-028

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Keywords: Unemployment; consumption commitments; optimal contracts;

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References

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  1. Raj Chetty & Adam Szeidl, 2007. "Consumption Commitments and Risk Preferences," The Quarterly Journal of Economics, MIT Press, vol. 122(2), pages 831-877, 05.
  2. Akerlof, George A & Miyazaki, Hajime, 1980. "The Implicit Contract Theory of Unemployment Meets the Wage Bill Argument," Review of Economic Studies, Wiley Blackwell, vol. 47(2), pages 321-38, January.
  3. Ellingsen, T. & Holden, S., 1995. "Sticky Consumption and Rigid Wages," Memorandum 21/1995, Oslo University, Department of Economics.
  4. Ellingsen, Tore & Holden, Steinar, 1997. "Indebtedness and Unemployment: A Durable Relationship," Working Paper Series in Economics and Finance 186, Stockholm School of Economics.
  5. Adam Szeidl & Raj Chetty, 2005. "Consumption Commitments: Neoclassical Foundations for Habit Formation," 2005 Meeting Papers 122, Society for Economic Dynamics.
  6. Azariadis, Costas, 1975. "Implicit Contracts and Underemployment Equilibria," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1183-1202, December.
  7. Baily, Martin Neil, 1974. "Wages and Employment under Uncertain Demand," Review of Economic Studies, Wiley Blackwell, vol. 41(1), pages 37-50, January.
  8. Stephen H. Shore & Todd Sinai, 2005. "Commitment, Risk, and Consumption: Do Birds of a Feather Have Bigger Nests?," NBER Working Papers 11588, National Bureau of Economic Research, Inc.
  9. Adam Szeidl & Raj Chetty, 2004. "Consumption Commitments and Asset Prices," 2004 Meeting Papers 354, Society for Economic Dynamics.
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Citations

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Cited by:
  1. Decreuse, Bruno & van Ypersele, Tanguy, 2010. "Housing market regulation and the social demand for job protection," CEPR Discussion Papers 7845, C.E.P.R. Discussion Papers.
  2. Schroyen, Fred, 2011. "Attitudes towards income risk in the presence of quantity constraints," Discussion Paper Series in Economics 7/2011, Department of Economics, Norwegian School of Economics.
  3. David Weiss & Cezar Santos, 2011. "Why Not Settle Down Already? A Quantitative Question," 2011 Meeting Papers 921, Society for Economic Dynamics.
  4. Luigi Guiso & Paolo Sodini, 2012. "Household Finance. An Emerging Field," EIEF Working Papers Series 1204, Einaudi Institute for Economics and Finance (EIEF), revised Mar 2012.
  5. SCHROYEN, Fred, 2011. "Attitudes towards income risk in the presence of quantity constraints," CORE Discussion Papers 2011020, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  6. University of Iowa & Galina Vereshchagina, 2007. "Preferences for risk in a dynamic model with consumption commitments," 2007 Meeting Papers 567, Society for Economic Dynamics.
  7. Drewianka, Scott, 2008. "Constrained labor supply and risk-aversion," Economics Letters, Elsevier, vol. 101(2), pages 130-133, November.
  8. Davidoff, Thomas, 2010. "Home equity commitment and long-term care insurance demand," Journal of Public Economics, Elsevier, vol. 94(1-2), pages 44-49, February.

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