Unemployment Insurance and Incentives

In this paper we present a partial economic equilibrium model of the labor market in which we maximize the workers' expected discounted utility level, while implying a zero expected profit for the firms.The model we use for the labor market takes into consideration transitions between the various states of employment and the time periods spent in each state. The probability distribution of these time periods may be arbitrary, not restricted to being exponential, as is the case for ordinary time-continuous Markov processes.The basic principles and difficulties arising from monitoring problems and moral hazard are discussed. In order to analyze unemployment insurance schemes that include incentives for workers to avoid unemployment, we depart from the simplest form of the principle of equivalence in insurance. Several different alternatives are discussed, all giving rise to partial insurance and thus incentives.We also analyze the effects that early retirement have on unemployment. Here, we include social security benefits in the economic model.Finally, we show that the optimal solutions entail quantity rationing. The Geneva Papers on Risk and Insurance Theory (1990) 15, 141–157. doi:10.1007/BF01489706