An Economic Theory of Involuntary Job Loss

Abstract

Formal economic theory provides robust explanations for voluntary unemployment that is the outcome of rational job search, market matching, and worker-retention or anti-shirking policies. Modern theorists, however, have had less success using the economic method of optimizing, price-mediated exchange to model unemployment resulting from involuntary job loss, an important real-world phenomena that economists should not ignore. In this paper, workplace-equilibrium analysis is used to formally model the two important classes of forced job separation, layoffs (expected to be temporary) and job destruction (expected to be permanent), producing results that are consistent with the available evidence. While the bulk of the analysis is done at the level of the work establishment, the job-loss model can be tractably aggregated, providing a powerful set of analytic tools for macroeconomists.