EMPLOYMENT RISK AND THE SUBSTITUTION BETWEEN SAVING AND UNEMPLOYMENT INSURANCE

This paper re-examines the comparative statics effects of increases in both the lump-sum and proportional components of an unemployment-insurance benefit on saving and labor supply. We analyze a two-period model of labor supply and saving that incorporates a known probability of being unemployed in the future. We show that, given risk aversion and the normality of leisure, the effects of increases in the lump-sum component on saving and labor supply are both negative. In the case of an increase in the replacement ratio, the relationship between unemployment insurance and saving depends on the weighted degree of absolute risk aversion, given risk aversion and the normality of leisure. Copyright � 2006 The Author; Journal compilation � 2006 Blackwell Publishing Ltd and The University of Manchester.