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Empirical evidence suggests that unemployed workers are much more likely to become self-employed than wage-employed workers. Also, higher unemployment benefits significantly reduce the rate of self-employment. This article develops a model of self-employment which incorporates transitions between unemployment and self-employment. It integrates two strands of theoretical literature—models of occupational choice and the efficiency wage models. In this model, a higher unemployment benefit reduces the self-employment rate and the transition rate of unemployed workers to self-employment, which is consistent with empirical evidence. (JEL J23, J58, J64)