Long-Term Commitments, Dynamic Optimization, and the Business Cycle

The thesis consists of three loosely connected essays. Each paper is a theoretical study of some form of long-term commitment made by economic agents. The goal is to relate the derived micro-level decision models to macroeconomic phenomena, especially the business cycle.

Chapter 1 analyzes the problem of making irreversible investment decisions when there is uncertainty about the true parameters of the stochastic economy. It is shown that increased uncertainty provides an incentive to defer such investments in order to wait for new information. Uncertainty and the volatility of investment demand are connected at the aggregate level.

In Chapter 2 we look at the commitment of resources to specific sectors of the economy. It is assumed that: relative sectoral productivities vary over time, and that it is costly to transfer resources between sectors. In both planning and market economy contexts, we show that dynamic considerations can make periods of unemployment and excess capacity part of an efficient growth path.

Chapter 3 studies labor contracting in an environment with capital and a quasi-fixed labor force. We argue that for exogenous reasons real labor contracts may be incomplete; i.e., unable to contain certain types of provisions. The resulting second-best contracts may lead to situations of apparent (but only apparent) labor market disequilibrium. The contracting model provides a framework for analyzing numerous sources of unemployment.