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INCENTIVES AND THE COST OF FIRING IN AN EQUILIBRIUM LABOR MARKET MODEL WITH ENDOGENOUS LAYOFFS

Authors

  • Cheng Wang

    1. Fudan University, China, and Iowa State University, U.S.A.
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    • 1I thank Yunan Li, Steve Williamson, the referees, and the editor for comments and advice. I also thank the Shanghai Pu Jiang Ren Cai program for financial support. All errors are mine. Please address correspondence to: Cheng Wang, School of Economics, Fudan University, Shanghai 200433, Phone: (86)(21) 5566-5609; Fax: (86)(21) 6564-7719; E-mail: wangcheng@fudan.edu.cn.


  • Manuscript received April 2011; revised May 2012.

Abstract

I study the effects of firing costs in an equilibrium model of the labor market with moral hazard. Layoff is an incentive device, modeled as termination of the optimal long-term contract. When the economy’s stock of firms is fixed, firing costs could reduce layoffs and increase worker welfare. In the long run when firms are free to enter and exit the market, firing costs generate not only lower employment, longer unemployment durations, and lower aggregate output, but also lower welfare for both employed workers and new labor market entrants.

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