Implicit contract theory

Azariadis originated and developed the concept of implicit contract theory.

Implicit contract theory suggests that if the agent is risk neutral, he or she takes all the risk.

Implicit contract theory attributes stable real wages to implied agreements between employers and workers.

Hence naturally, economists tried to extend and apply the implicit contract theory to explain these phenomena in the capital market.

Thus, despite its declining popularity among labor economists, implicit contract theory still plays an important role in understanding capital market imperfections.

Economists have several theories explaining the possibility of involuntary unemployment including implicit contract theory, disequilibrium theory, staggered wage setting, and efficiency wages.

Implicit contracts theory was first developed to explain why there are quantity adjustments (layoffs) instead of price adjustments (falling wages) in the labor market during recessions.

Economists have three main groups of theories for explaining real rigidities in the labor market: implicit contract theories, efficiency wage theories, and insider-outsider theories.

Models based on implicit contract theory, like that of Azariadis (1975), are based on the hypothesis that labor contracts make it difficult for employers to cut wages.

This type of involuntary unemployment is consistent with Keynes's definition while efficiency wages and implicit contract theory do not fit well with Keynes's focus on demand deficiency.

Despite the popularity of implicit contract theory in the 1980s, applications of the implicit contracts theory in labor economics has been in decline since 1990s.