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The Optimal Dole with Risk Aversion, Job Destruction, and Worker Heterogeneity

Author

Listed:
  • Carl Davidson

    (Michigan State University)

  • Stephen A. Woodbury

    () (W.E. Upjohn Institute for Employment Research)

Abstract

This paper extends earlier research on optimal unemployment insurance (UI) by developing an equilibrium search model that encompasses simultaneously several theoretical and institutional features that have been treated one-by-one (or not at all) in previous discussions of optimal UI. In particular, the model we develop allows us to determine the optimal potential duration of UI benefits as well as the optimal UI benefit amount; assumes (realistically) that not all workers are eligible for UI benefits; allows examination of various degrees of risk aversion by workers; models labor demand so that the job destruction effects of UI are taken into account; and treats workers as heterogeneous. The model suggests that the current statutory replacement rate of 50 percent provided by most states in the United States is close to optimal, but that the current potential duration of benefits (which is usually 26 weeks) is probably too short. This basic result--that the optimal UI system is characterized by a fairly low replacement rate and a long potential duration-- conflicts with most of the existing literature on optimal UI. We argue, however, that the result is consistent with a large literature on optimal insurance contracts in the presence of moral hazard.

Suggested Citation

  • Carl Davidson & Stephen A. Woodbury, 1997. "The Optimal Dole with Risk Aversion, Job Destruction, and Worker Heterogeneity," Upjohn Working Papers and Journal Articles 97-47, W.E. Upjohn Institute for Employment Research.
  • Handle: RePEc:upj:weupjo:97-47
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    References listed on IDEAS

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    1. Zeldes, Stephen P, 1989. "Consumption and Liquidity Constraints: An Empirical Investigation," Journal of Political Economy, University of Chicago Press, vol. 97(2), pages 305-346, April.
    2. Wang, Cheng & Williamson, Stephen, 1996. "Unemployment insurance with moral hazard in a dynamic economy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 44(1), pages 1-41, June.
    3. Fredriksson, Peter & Holmlund, Bertil, 2001. "Optimal Unemployment Insurance in Search Equilibrium," Journal of Labor Economics, University of Chicago Press, vol. 19(2), pages 370-399, April.
    4. Michael Rothschild & Joseph Stiglitz, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, Oxford University Press, vol. 90(4), pages 629-649.
    5. Davidson, Carl & Woodbury, Stephen A., 1997. "Optimal unemployment insurance," Journal of Public Economics, Elsevier, vol. 64(3), pages 359-387, June.
    6. Christopher J. O'Leary, 1998. "The Adequacy of Unemployment Insurance Benefits," Book chapters authored by Upjohn Institute researchers,in: Laurie J. Bassi & Stephen A. Woodbury (ed.), Reform of the Unemployment Insurance System: Research in Employment Policy, volume 1, pages 63-110 W.E. Upjohn Institute for Employment Research.
    7. Shavell, Steven & Weiss, Laurence, 1979. "The Optimal Payment of Unemployment Insurance Benefits over Time," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1347-1362, December.
    8. Flemming, J. S., 1978. "Aspects of optimal unemployment insurance : Search, leisure, savings and capital market imperfections," Journal of Public Economics, Elsevier, vol. 10(3), pages 403-425, December.
    9. Davidson, Carl & Woodbury, Stephen A, 1993. "The Displacement Effect of Reemployment Bonus Programs," Journal of Labor Economics, University of Chicago Press, vol. 11(4), pages 575-605, October.
    10. Lars Ljungqvist & Thomas J. Sargent, 1998. "The European Unemployment Dilemma," Journal of Political Economy, University of Chicago Press, vol. 106(3), pages 514-550, June.
    11. Dale T. Mortensen, 1994. "Reducing supply-side disincentives to job creation," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, issue Jan, pages 189-237.
    12. Card, David & Levine, Phillip B., 1994. "Unemployment insurance taxes and the cyclical and seasonal properties of unemployment," Journal of Public Economics, Elsevier, vol. 53(1), pages 1-29, January.
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    14. Stephen A. Woodbury, 2009. "Unemployment," Chapters,in: Labor and Employment Law and Economics, chapter 17 Edward Elgar Publishing.
    15. Carl Davidson & Stephen A. Woodbury, 1996. "Unemployment Insurance and Unemployment Implications of the Reemployment Bonus Experiments," Book chapters authored by Upjohn Institute researchers,in: Advisory Council on Unemployment Compensation: Background Papers, volume 3, pages KK1-KK37 W.E. Upjohn Institute for Employment Research.
    16. Paul Storer & Marc A. Van Audenrode, 1995. "Unemployment Insurance Take-Up Rates in Canada: Facts, Determinants, and Implications," Canadian Journal of Economics, Canadian Economics Association, vol. 28(4a), pages 822-835, November.
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    Citations

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    Cited by:

    1. David Fuller & Stephane Auray & Damba Lkhagvasuren, 2013. "Unemployment Insurance Take-up Rates in an Equilibrium Search Model," Working Papers 13001, Concordia University, Department of Economics.
    2. Fuller, David L., 2014. "Adverse selection and moral hazard: Quantitative implications for unemployment insurance," Journal of Monetary Economics, Elsevier, vol. 62(C), pages 108-122.

    More about this item

    Keywords

    unemployment insurance; job destruction; Davidson; Woodbury;

    JEL classification:

    • J0 - Labor and Demographic Economics - - General
    • J2 - Labor and Demographic Economics - - Demand and Supply of Labor
    • J6 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers

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