Comparative Statics Proposition 2

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Figure 2: The left panel shows that more risk-aversion makes indifference curves steeper, and lowers the equilibrium wage and queue length. The right panel shows that higher UI makes indifference curves flatter, having the opposite effect.

The first part states that with more risk-averse workers, wages are lower, job queues are shorter and firms invest less. The second part shows that with decreasing absolute risk aversion (DARA), poorer workers are effectively more risk-averse. The third part shows that higher UI increases wages, unemployment and capital-labor ratios.

The Appendix contains a formal proof of Proposition 2, but the idea can be seen graphically in Figure 2. Firms5 zero profit condition (2) is unaffected by preferences, assets, and UI. The comparative statics are therefore due exclusively to changes preferences. More risk-averse workers have indifference curves that are everywhere steeper. In contrast, when UI increases, the new set of indifference curves is everywhere flatter. For example, as indifference curves become flatter, the point of tangency must shift to the right, to a point of higher wages and longer job queues. The comparative static results are always unambiguous because the sets of indifference curves cross only once.

The intuition of Proposition 2 is a good way of illustrating the key innovations of our analysis. Frictional matching introduces an inherent risk as workers may remain unemployed and suffer low consumption. In the absence of UI, the labor market offers its own brand of insurance as firms see the profit opportunities in creating jobs with lower unemployment risk, and charge an “insurance premium” to risk-averse workers by offering lower wages. This market insurance also affects the form of production in the economy, because opening a large number of jobs creates high “vacancy risk” for firms, reducing investment and capital intensity. The reason why there is no separation between the consumption and production sides of this economy is incomplete insurance. In the presence of complete insurance, workers would maximize their expected income and capital-labor ratios would not respond to changes in risk-aversion. Electronic Payday Loans Online