Three applications of market incompleteness and market imperfection
Creators: name: Jitsuchon, Somchai
Publisher: name: University of British Columbia
Year: 2009

description: This thesis presents two applications of the incompleteness and one application of the imperfection of the market economy. The first application, Chapter 2, studies the decision making problem of an individual seeking to accumulate an optimal amount of human capital realizing that the wage income derived from the accumulated human capital is subject to incompletely insured uncertainty. In other words, the financial market that insures against wage income risk is not fully functional. We find that the individual's inability to diversify wage income risk tends to increase the need to accumulate more human capital in order to elevate wage path and compensate for the burden of its associated risk. This is particularly true when (i) the wage income risk is positively correlated with the rate-of-return risk in the financial market, resulting in an even greater risk burden to the individual, and (ii) the individual is more risk averse. There are two possibilities that no human capital is needed. The first possibility occurs when it is optimal to work as an unskilled worker because both the burden from wage income risk and the rate of return from education are low. The second possibility is the case where the risk burden is so high that the optimal time spent in school to acquire sufficient human capital to cover the risk is so long that the discounted rate of return from education is negative. In this case, the best strategy is to invest in financial assets alone and forfeit the opportunity to earn wage income - either as an educated or as an unskilled worker - to avoid its associated risk. Chapter 3 applies equilibrium unemployment theory with a frictional labor market to study the impact of immigration on the local labor market. Markets are imperfect in the sense that job matching takes time and recruitment is costly. We find that labor market outcomes of both the natives and existing immigrants depend crucially on how the economic surplus from successful matching is divided between the firms and the workers or, in other words, on the bargaining power of the workers. An arrival of immigrants with low bargaining power tends to benefit both the natives and the existing immigrants. A disparity between the two worker types in the matching efficiency also plays a major role. An inferior matching technology among the immigrants, interpreted here as reflecting their less established social network, lowers their wage rate and increases their unemployment rate. The natives are more likely to benefit from additional immigration than the existing immigrants and, when they do, the overall benefit can be decomposed into "job creation spillover" effect resulting from the immigrants' low bargaining power, and "job stealing" effect resulting from the immigrants' less efficient matching. The implications on the pattern of international migration flows are also discussed. In Chapter 4, a simple macroeconomic model is constructed and applied quantitatively to OECD countries, to analyze the effect of incomplete insurance on saving, growth and welfare in a closed economy. In this economy, precautionary saving motivated by uninsured idiosyncratic shocks raises growth rates but lowers risk-free returns. Welfare is measured by the sum of growth rates and risk-free rates of return, not growth rates alone. This welfare measure takes the negative impact of precautionary saving into consideration. Applied to the OECD data, three major results emerge: (i) the heterogeneous performance of growth and saving across the countries reflects different degrees of insurance incompleteness, (ii) since the externality of growth on productivity was very strong in the 1960's, the heavily constrained insurance market itself improves productivity by promoting growth, thereby enhancing welfare, (iii) while the externality of growth became weaker in the 1980's, the development of insurance markets lowered growth, but still contributed to a raise in welfare.