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Unemployment and Insurance

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  • Sherwin Rosen

Abstract

This paper elaborates equilibrium properties of contract labor markets when cost barriers limit labor mobility in response to demand and productivity shifts. Unemployment is sustained because the marginal value of labor is not equated across all firms; however the equilibrium contract optimally allocates a worker's time between market and nonmarket uses, given transactions cost-mobility constraints. Contracts provide full unemployment insurance for risks that are diversifiable by pooling among firms. Nondiversifiable (macro) risks are only partially shifted,largely through self-insurance (contingency saving). Increasing diversifiable risk has social value, similar to the value of an option. Increasing nondiversifiable risk has negative value because it reduces lifetime consumption. The main empirical implication of contract theory is shown to be closely related to the permanent income hypothesis and establishes linkages between labor activities and consumption behavior. It is atheory of consumption rigidity rather than wage rigidity. Another empirical implication is that unemployment incidence is proportional to comparative advantage in normarket production. Layoffs are ordered by workers' relative productivity in nonmarket compared with market sectors. The theory is used to analyze some features of the U.S. employment system. Its empirical support is briefly reviewed.

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  • Sherwin Rosen, 1983. "Unemployment and Insurance," NBER Working Papers 1095, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:1095
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    References listed on IDEAS

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    1. V.V. Chari, 1980. "Involuntary Unemployment and Implicit Contracts," Discussion Papers 459, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    2. Hall, Robert E & Lazear, Edward P, 1984. "The Excess Sensitivity of Layoffs and Quits to Demand," Journal of Labor Economics, University of Chicago Press, vol. 2(2), pages 233-257, April.
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    Cited by:

    1. Abraham, Katharine G & Katz, Lawrence F, 1986. "Cyclical Unemployment: Sectoral Shifts or Aggregate Disturbances?," Journal of Political Economy, University of Chicago Press, vol. 94(3), pages 507-522, June.
    2. Robert H. Topel & Finis Welch, 1986. "Efficient Labor Contracts with Employment Risk," RAND Journal of Economics, The RAND Corporation, vol. 17(4), pages 490-507, Winter.
    3. Baxter, J. L. & Moosa, I. A., 1996. "The consumption function: A basic needs hypothesis," Journal of Economic Behavior & Organization, Elsevier, vol. 31(1), pages 85-100, October.
    4. Glismann, Hans H. & Schrader, Klaus, 2001. "Alternative Systeme der Arbeitslosenversicherung: das Beispiel der Vereinigten Staaten und des Vereinigten K├Ânigreichs," Kiel Working Papers 1032, Kiel Institute for the World Economy (IfW).

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