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Incomplete Information, Risk Shifting, and Employment Fluctuations

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  • Herschel I. Grossman

Abstract

This paper explores one of the ways in which acceptance of the hypothesis that labor market transactions involve arrangements for shifting risk from workers to employers strengthens the case for accepting the hypothesis that incomplete information is the critical factor in producing the positive effect of aggregate demand for output on aggregate employment. The analysis shows that the introduction of risk-shifting arrangements into models of incomplete information eliminates the dependence of the relation between aggregate demand and aggregate employment on the relative strengths of the usual substitution and income effects on labor supply of perceived real wage rates or perceived real interest rates. In addition, the analysis shows that the apparent fact that workers choose an amount of risk shifting that gives them constant nominal wage rates implies that incomplete information would produce a positive effect of aggregate demand on aggregate employment. The key to these results is that risk shifting allows workers to use the value of product associated with high levels of demand to supplement the income associated with low levels of demand. Consequently, they can choose high employment instates of high demand without causing a corresponding reduction in their expected marginal utility of consumption.
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  • Herschel I. Grossman, 1981. "Incomplete Information, Risk Shifting, and Employment Fluctuations," Review of Economic Studies, Oxford University Press, vol. 48(2), pages 189-197.
  • Handle: RePEc:oup:restud:v:48:y:1981:i:2:p:189-197.
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    File URL: http://hdl.handle.net/10.2307/2296879
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    References listed on IDEAS

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    1. Grossman, Herschel I, 1979. "Employment Fluctuations and the Mitigation of Risk," Economic Inquiry, Western Economic Association International, vol. 17(3), pages 344-358, July.
    2. Azariadis, Costas, 1978. "Escalator clauses and the allocation of cyclical risks," Journal of Economic Theory, Elsevier, vol. 18(1), pages 119-155, June.
    3. Grossman, Herschel I., 1978. "Risk shifting, layoffs, and seniority," Journal of Monetary Economics, Elsevier, vol. 4(4), pages 661-686, November.
    4. Seater, John J., 1977. "A unified model of consumption, labor supply, and job search," Journal of Economic Theory, Elsevier, vol. 14(2), pages 349-372, April.
    5. Barro, Robert J., 1977. "Long-term contracting, sticky prices, and monetary policy," Journal of Monetary Economics, Elsevier, vol. 3(3), pages 305-316, July.
    6. Herschel I. Grossman, 1980. "Risk Shifting, Unemployment Insurance, and Layoffs," NBER Working Papers 0424, National Bureau of Economic Research, Inc.
    7. Seater, John J., 1978. "Utility maximization, aggregate labor force behavior, and the Phillips curve," Journal of Monetary Economics, Elsevier, vol. 4(4), pages 687-713, November.
    8. Grossman, Herschel I, 1977. " Risk Shifting and Reliability in Labor Markets," Scandinavian Journal of Economics, Wiley Blackwell, vol. 79(2), pages 187-209.
    9. Barro, Robert J., 1976. "Rational expectations and the role of monetary policy," Journal of Monetary Economics, Elsevier, vol. 2(1), pages 1-32, January.
    10. Grossman, Herschel I, 1979. "Why Does Aggregate Employment Fluctuate?," American Economic Review, American Economic Association, vol. 69(2), pages 64-69, May.
    11. Lucas, Robert E., 1977. "Understanding business cycles," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 5(1), pages 7-29, January.
    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 721-754, Sept./Oct.
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    Cited by:

    1. John Haltiwanger, 1982. "Specific CApital, Long Term Implicit Contracts, and Temporary Layoffs," UCLA Economics Working Papers 245, UCLA Department of Economics.
    2. Grossman, Herschel I., 1983. "The natural-rate hypothesis, the rational-expectations hypothesis, and the remarkable survival of non-market-clearing assumptions," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 19(1), pages 225-245, January.
    3. Haltiwanger, John, 1984. "The Distinguishing Characteristics of Temporary and Permanent Layoffs," Journal of Labor Economics, University of Chicago Press, vol. 2(4), pages 523-538, October.

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