There are two main economic reasons why we might want to provide benefits to those who are out of work. First, sometimes people lose their jobs unexpectedly, leading to a large negative income shock. In general, people would like to insure themselves against this risk, paying insurance while in work so that they receive payouts when they lose their job.
There are limited private markets for unemployment insurance due to two main market failures. One is ‘adverse selection’ – those who know they are unlikely to become unemployed probably won’t want to purchase insurance, as the premium will be too high. Therefore, only those with a higher risk of unemployment would buy insurance, pushing up insurers’ costs and leading to higher premia. In turn, more people drop out of the market until only those with the very highest risk would buy insurance.
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