Adverse Selection and Employment Cycles

This article examines a dynamic adverse‐selection model that generates equilibrium employment cycles. In the model, firms hire workers from unemployment, observe workers' productivity through time, and (following the profit‐maximizing rule) eventually fire unproductive workers. If hiring costs...

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Bibliographic Details
Published in:Journal of labor economics 1999-04, Vol.17 (2), p.281-297
Main Author: Montgomery, James D.
Format: Article
Language:English
Subjects:
Adverse selection
Cost analysis
Costs
Cyclical analysis
Dynamical systems
Economic models
Employment
Employment termination
Equilibrium
Hiring
Job hunting
Job search
Labor economics
Profit
Skill differentials
Studies
Unemployment
Workers
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Summary:This article examines a dynamic adverse‐selection model that generates equilibrium employment cycles. In the model, firms hire workers from unemployment, observe workers' productivity through time, and (following the profit‐maximizing rule) eventually fire unproductive workers. If hiring costs are low, the dynamical system converges to a steady state in which the unemployment pool contains mostly low‐ability workers. However, if hiring costs are sufficiently large, this “lemons effect” would make firms unwilling to hire workers. In this case, the system converges to a cyclical equilibrium in which firms alternate between hiring and not hiring.
ISSN:0734-306X
1537-5307
DOI:10.1086/209921