Consumption Commitments and Employment Contracts

Abstract:     
We examine an economy in which the cost of consuming some goods can be reduced by making commitments that reduce flexibility. We show that such consumption commitments can induce consumers with risk-neutral underlying utility functions to be risk averse over small variations in income, but sometimes to seek risk over large variations. As a result, optimal employment contracts will smooth wages conditional on being employed, but may incorporate a possibility of unemployment.

Note: A previous version of this paper can be found at: http://ssrn.com/abstract=877314

Number of Pages in PDF File: 32

Keywords: Unemployment, consumption commitments, optimal contracts

JEL Classification: D21, D31, D81, J34

working papers series