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Unemployment with Observable Aggregate Shocks

  • Sanford J. Grossman
  • Oliver D. Hart
  • Eric Maskin

Consider an economy subject to two kinds of shocks: (a) an observable shock to the relative demand for final goods which causes dispersion in relative prices, and (b) shocks, unobservable by workers, to the technology for transforming intermediate goods into final goods. A worker in a particular intermediate goods industry knows that the unobserved price of his output is determined by (1) the technological shock that determines which final goods industry uses his output intensively and (2) the price of the final good that uses his output intensively. When there is very little relative price dispersion among final goods, then it doesn't matter which final goods industry uses the worker's output. Thus the technological shock is of very little importance in creating uncertainty about the worker's marginal product when there is little dispersion of relative prices. Hence an increase in the dispersion of relative prices amplifies the effect of technological uncertainty on a worker's marginal value product. We consider a model of optimal labor contracts in a situation where the workers have less information than the firm about their marginal value product. A relative price shock of the type described above increases the uncertainty which workers have about their marginal value product. We show that with an optimal asymmetric information employment contract the industries which are adversely affected by the relative price shock will contract more than they would under complete information (i.e., where workers could observe their marginal value product). On the other hand the industry which is favorably affected by the relative price shock will - not expand by more than would be the case under complete information. Hence an observed relative demand shock, which would leave aggregate employment unchanged under complete information, will cause aggregate employment to fall under asymmetric information about the technological shock.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0975.

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Date of creation: Sep 1982
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Publication status: published as Grossman, Sanford J., Oliver Hart and Eric Maskin. "Unemployment with Observable Aggregate Shocks." Journal of Political Economy. (December 1983), pp. 907-928.
Handle: RePEc:nbr:nberwo:0975
Note: ME
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  1. Holmstrom, Bengt R & Weiss, Laurence, 1985. "Managerial Incentives, Investment, and Aggregate Implications: Scale Effects," Review of Economic Studies, Wiley Blackwell, vol. 52(3), pages 403-25, July.
  2. Fischer, Stanley, 1982. "Relative price variability and inflation in the United States and Germany," European Economic Review, Elsevier, vol. 18(2), pages 171-196.
  3. Blanchard, Olivier Jean, 1979. "Wage Indexing Rules and the Behavior of the Economy," Journal of Political Economy, University of Chicago Press, vol. 87(4), pages 798-815, August.
  4. Stanley Fischer & Franco Modigliani, 1978. "Towards An Understanding of the Real Effects and Costs of Inflation," NBER Working Papers 0303, National Bureau of Economic Research, Inc.
  5. Fischer, Stanley, 1982. "Relative price variability and inflation in the United States and Germany," European Economic Review, Elsevier, vol. 18(1), pages 171-196.
  6. Parks, Richard W, 1978. "Inflation and Relative Price Variability," Journal of Political Economy, University of Chicago Press, vol. 86(1), pages 79-95, February.
  7. Sanford Grossman & Laurence Weiss, 1980. "Heterogeneous Information and the Theory of the Business Cycle," Cowles Foundation Discussion Papers 558, Cowles Foundation for Research in Economics, Yale University.
  8. repec:nbr:nberre:0126 is not listed on IDEAS
  9. Dasgupta, Partha S & Hammond, Peter J & Maskin, Eric S, 1979. "The Implementation of Social Choice Rules: Some General Results on Incentive Compatibility," Review of Economic Studies, Wiley Blackwell, vol. 46(2), pages 185-216, April.
  10. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
  11. Harris Milton & Townsend, Robert M, 1981. "Resource Allocation under Asymmetric Information," Econometrica, Econometric Society, vol. 49(1), pages 33-64, January.
  12. 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.
  13. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
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