Abstract
A general equilibrium model of optimal employment contracts is developed where firms have better information about labor's marginal product than workers. It is optimal for the wage to be tied to the level of employment, to prevent the firm from falsely stating that the marginal product is low and cutting the wage. It is shown that an observed aggregate shock that leads to an interindustry shift in labor demand and that would have no effect on total employment under symmetric information leads to a reduction in employment when firms and workers have asymmetric information.
Highlights
Recent theories of the business cycle have emphasized the misallocations associated with unobserved aggregate shocks.' Agents are assumed to have insufficient information to distinguish changes in theivrelative position from those in their absolute position
Tile model has the property that an observed increase in the dispersion of relative final goods prices causes an increase in the uncertainty workers have about their own marginal value products. This situation, where each worker knows more about general economic conditions than about conditions in his own industry, is in contrast to Lucas's (1972) assumption that workers know more about their own firmnsp' rice than they know about the economy-wide price level
Relative Price Variabilityas a Cause ou/Aggregate Output Variability In Section IV we outlined a model in which relative price shocks inake workers uncertain about their marginal value products
Summary
Recent theories of the business cycle have emphasized the misallocations associated with unobserved aggregate shocks.' Agents are assumed to have insufficient information to distinguish changes in theivrelative position from those in their absolute position. Tile model has the property that an observed increase in the dispersion of relative final goods prices causes an increase in the uncertainty workers have about their own marginal value products This situation, where each worker knows more about general economic conditions than about conditions in his own industry (since each consumes goods produced in many industries), is in contrast to Lucas's (1972) assumption that workers know more about their own firmnsp' rice than they know about the economy-wide price level. Using the results of' Sections II and III, Section IV shows that an increase in the dispersion of relative prices that leaves the complete information Walrasian equilibrium unchanged causes a fall in employment under asymmetric information This is proved under the assumption that, ex ante, workers and firms write an optimal labor contract that appropriately is conditioned on everything that will be observable to both parties. A wealth redistribution that would have no effect on total employment when agents have symmetric information will cause employment to fall when they are asymmetrically informed
Sign-in/Register to view highlights & summary Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
