Unemployment and Wage Rigidity When Labor Supply is a Household Decision

UC Irvine Economics Working Paper No. 00-01-11

46 Pages Posted: 4 Nov 2001

See all articles by Kaushik Basu

Kaushik Basu

Cornell University - Department of Economics; Harvard University - Harvard Institute of Economic Research; IZA Institute of Labor Economics; World Bank

Garance Genicot

Georgetown University - Department of Economics

Joseph E. Stiglitz

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Date Written: October 2000

Abstract

If people's labor-supply decisions are taken at the level of the household, it is natural to expect aggregate demand and unemployment to influence the supply curve of labor. An increase in unemployment could prompt households to send more workers out in search of work to insure against the risk of the primary worker getting unemployed (the "added worker effect"). But it could also discourage people from wasting energy searching for work (the "discouragement effect"). While these effects have been studied empirically, their theoretical bases remain largely unexplored. The present paper formally models household labor supply decisions and establishes sufficient conditions for the domination of one effect over the other. A number of surprising results are established, such as the possibility of multiple equilibria in the labor market and how the announcement of a minimum wage policy can result in an overall lowering of wages and also give rise to an equilibrium which displays, simultaneously, excess demand and excess supply of labor. The model shows how the empirical literature may have a bias in overestimating the strength of the discouragement effect. It also provides a framework for analyzing the effects of minimum wage policy and the provision of unemployment benefits. It is argued that certain kinds of unemployment benefits can be justified on grounds of efficiency.

Keywords: added worker, labor supply, unemployment, minimum wage, efficiency wage

JEL Classification: D10, J64, K31

Suggested Citation

Basu, Kaushik and Genicot, Garance and Stiglitz, Joseph E., Unemployment and Wage Rigidity When Labor Supply is a Household Decision (October 2000). UC Irvine Economics Working Paper No. 00-01-11. Available at SSRN: https://ssrn.com/abstract=288695 or http://dx.doi.org/10.2139/ssrn.288695

Kaushik Basu

Cornell University - Department of Economics ( email )

414 Uris Hall
Ithaca, NY 14853-7601
United States
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Harvard University - Harvard Institute of Economic Research ( email )

Department of Economics
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IZA Institute of Labor Economics

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World Bank

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Garance Genicot (Contact Author)

Georgetown University - Department of Economics ( email )

Washington, DC 20057
United States
202-687-7144 (Phone)
202-687-6102 (Fax)

HOME PAGE: http://www.georgetown.edu/faculty/gg58

Joseph E. Stiglitz

Columbia Business School - Finance and Economics ( email )

3022 Broadway
814 Uris Hall
New York, NY 10027
United States
(212) 854-0671 (Phone)
(212) 662-8474 (Fax)

HOME PAGE: http://www.josephstiglitz.com

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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