Question

Question 2

Explain three mutually reinforcing effects that tend to increase duration of unemployment spells as a result of income replacement programs such as unemployment benefits.                                                                      

Answer 1

Three reasons are:

• Moral hazard: People tend to look for jobs less as benefits are better for some than with their job. This, in turn, leads to an increased duration of unemployment.
• Liquidity Constraint: People search for low-wage jobs or jobs in which they aren't skilled in meeting their consumption demand; this creates a lag. They will get their job eventually, but still, this increases the duration of unemployment.
• The third one will be the time duration of benefits. It is found that extension in unemployment benefits increases the unemployment spell drastically.

The article used for the review: The impact of the potential duration of unemployment benefits on the duration of unemployment, By Katz, Lawrence F.; Meyer, Bruce D, 1990.

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