Incomplete Information, Risk Shifting, and Employment Fluctuations / Herschel I. Grossman.

By:

Grossman, Herschel I

Contributor(s):

National Bureau of Economic Research

Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w0534.Publication details: Cambridge, Mass. National Bureau of Economic Research 1980.Description: 1 online resource: illustrations (black and white)Online resources:

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Abstract: This paper explores one of the ways in which acceptance of the hypothesis that labor market transactions involve arrangements for shifting risk from workers to employers strengthens the case for accepting the hypothesis that incomplete information is the critical factor in producing the positive effect of aggregate demand for output on aggregate employment. The analysis shows that the introduction of risk-shifting arrangements into models of incomplete information eliminates the dependence of the relation between aggregate demand and aggregate employment on the relative strengths of the usual substitution and income effects on labor supply of perceived real wage rates or perceived real interest rates. In addition, the analysis shows that the apparent fact that workers choose an amount of risk shifting that gives them constant nominal wage rates implies that incomplete information would produce a positive effect of aggregate demand on aggregate employment. The key to these results is that risk shifting allows workers to use the value of product associated with high levels of demand to supplement the income associated with low levels of demand. Consequently, they can choose high employment instates of high demand without causing a corresponding reduction in their expected marginal utility of consumption.

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Previous	nber w0531 Policy Decentralization and Exchange Rate Management in Interdependent Economies /	nber w0532 Microeconomic Aspects of Productivity Growth under Import Substitution: Turkey /	nber w0533 The Tax Advantages of Pension Fund Investments in Bonds /	nber w0534 Incomplete Information, Risk Shifting, and Employment Fluctuations /	nber w0535 Some Aspects of the Canadian Experience with Flexible Exchange Rates in the 1970s /	nber w0536 Further Evidence on the Value of Professional Investment Research /	nber w0537 Exchange-Rate Expectations and Nominal Interest Differentials: A Test ofthe Fisher Hypothesis /	Next

August 1980.

This paper explores one of the ways in which acceptance of the hypothesis that labor market transactions involve arrangements for shifting risk from workers to employers strengthens the case for accepting the hypothesis that incomplete information is the critical factor in producing the positive effect of aggregate demand for output on aggregate employment. The analysis shows that the introduction of risk-shifting arrangements into models of incomplete information eliminates the dependence of the relation between aggregate demand and aggregate employment on the relative strengths of the usual substitution and income effects on labor supply of perceived real wage rates or perceived real interest rates. In addition, the analysis shows that the apparent fact that workers choose an amount of risk shifting that gives them constant nominal wage rates implies that incomplete information would produce a positive effect of aggregate demand on aggregate employment. The key to these results is that risk shifting allows workers to use the value of product associated with high levels of demand to supplement the income associated with low levels of demand. Consequently, they can choose high employment instates of high demand without causing a corresponding reduction in their expected marginal utility of consumption.