LABRST 3A03 Lecture Notes - Lecture 12: Adverse Selection, Human Capital
14 Dec 2017
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Reasons: the main worker assets- human capital- are not diversifiable (to reduce risk) Innate risk preferences: entrepreneurs are mostly risk-neutral and risk-lovers, employees (wages earners) are most risk-averse, cautious. Private markets for income insurance don"t exist due to two reasons. Moral hazard: individuals can influence the risk against which they are insured. Adverse selection: insurer cannot observe the risk that a particular insure presents. Implicit contract theory applies situations in which there is a long term relationship btwn the firm and its workers. The firms provide insurance only to its own employees, thus avoiding adverse selection problem. The firm controls probability of income loss due to layoff or wage/hour reduction, thus avoiding the moral hazard problem. N0 workers attached to the firm and the value of leisure is k. In the good state n0 workers are employed, earning wa. In the bad state nb workers are employed, earning wb.
