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Adverse Selection and Employment Cycles

  • Montgomery, James D
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    This article examines a dynamic adverse-selection model that generates equilibrium employment cycles. In the model, firms hire workers from unemployment, observe workers' productivity through time, and (following the profit-maximizing rule) eventually fire unproductive workers. If hiring costs are low, the dynamical system converges to a steady state in which the unemployment pool contains mostly low-ability workers. However, if hiring costs are sufficiently large, this 'lemons effect' would make firms unwilling to hire workers. In this case, the system converges to a cyclical equilibrium in which firms alternate between hiring and not hiring. Copyright 1999 by University of Chicago Press.

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    File URL: http://dx.doi.org/10.1086/209921
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    Article provided by University of Chicago Press in its journal Journal of Labor Economics.

    Volume (Year): 17 (1999)
    Issue (Month): 2 (April)
    Pages: 281-97

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    Handle: RePEc:ucp:jlabec:v:17:y:1999:i:2:p:281-97
    Contact details of provider: Web page: http://www.journals.uchicago.edu/JOLE/

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    1. Fershtman, C. & Fishman, A., 1989. "Price Cycles And Booms Dynamic Search Equilibrium," Papers 8922, Tilburg - Center for Economic Research.
    2. Gibbons, R. & Katz, L.F., 1989. "Layoffs And Lemons," Working papers 531, Massachusetts Institute of Technology (MIT), Department of Economics.
    3. Albrecht, James W & Axell, Bo, 1983. "An Equilibrium Model of Search Unemployment," Working Paper Series 99, Research Institute of Industrial Economics.
    4. Diamond, Peter A., 1971. "A model of price adjustment," Journal of Economic Theory, Elsevier, vol. 3(2), pages 156-168, June.
    5. John Conlisk & Eitan Gerstner & Joel Sobel, 1984. "Cyclic Pricing by a Durable Goods Monopolist," The Quarterly Journal of Economics, Oxford University Press, vol. 99(3), pages 489-505.
    6. Montgomery, James D, 1991. "Social Networks and Labor-Market Outcomes: Toward an Economic Analysis," American Economic Review, American Economic Association, vol. 81(5), pages 1407-18, December.
    7. Devine, Theresa J. & Kiefer, Nicolas M., 1991. "Empirical Labor Economics: The Search Approach," OUP Catalogue, Oxford University Press, number 9780195059366, December.
    8. Jovanovic, Boyan, 1984. "Matching, Turnover, and Unemployment," Journal of Political Economy, University of Chicago Press, vol. 92(1), pages 108-22, February.
    9. George A. Akerlof, 1970. "The Market for "Lemons": Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, Oxford University Press, vol. 84(3), pages 488-500.
    10. Bruce C. Greenwald, 1986. "Adverse Selection in the Labour Market," Review of Economic Studies, Oxford University Press, vol. 53(3), pages 325-347.
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