On Implicit Contracts and Involuntary Unemployment
1982-06
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On Implicit Contracts and Involuntary Unemployment
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1982-06
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Center for Economic Research, Department of Economics, University of Minnesota
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Working Paper
Abstract
We show that a firm can increase expected profits by undertaking the
additional expense of paying unemployment compensation to the workers
its lays off, it they are risk averse. When this argument is applied to
the implicit contract models it makes the involuntary unemployment derived
there disappear, where by involuntary unemployment we mean a situation in
which one worker has a job at a wage wand another worker who is known
to be productively identical and willing to take on the job at a lower wage
h cannot find a job.
We introduce into our model asymmetric information between sectors of
the economy. Each agent knows the state of his own firm but not that of
others. We suppose also that workers have specific skills which are conformable
to some, but not all, firms in the economy. In this model we reestablish
the phenomenon of involuntary unemployment in a general implicit contracts
equilibrium in which the proportion of layoffs, the "stabilized" wage,
and the severance payments are endogenously determined. Moreover, we show
that the presence of involuntary unemployment is a signal that there is too
little output in the most productive sectors of the economy, thereby restoring
the link between underproduction and involuntary unemployment missing in
the implicit contracts literature. Finally we ask how large should be
the severance payment a profit maximizing firm gives to each worker from
a branch it shuts down, when there is uncertainty about what jobs those
workers will find. We prove that the rational expected-profit-maximizing
firm will offer a contract which provides severance compensation so generous
that on average the workers dismissed by the closing of a plant can expect
to be better off than if they had been retained, in the case that they have
decreasing absolute risk aversion.
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Previously Published Citation
Geanakoplos, J. and Ito, T., (1982), "On Implicit Contracts and Involuntary Unemployment", Discussion Paper No. 155, Center for Economic Research, Department of Economics, University of Minnesota.
Suggested citation
Geanakoplos, John; Ito, Takatoshi. (1982). On Implicit Contracts and Involuntary Unemployment. Retrieved from the University Digital Conservancy, https://hdl.handle.net/11299/55130.
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