Innovations in labor contracts. I present a model of labor contracts where the optimal wage depends on prices and the firm's performance. If wages are not contingent on these variables, movements in these variables create distortion costs. If wages are indexed to prices, distortion costs decline, optimal contract length rises and so do the distortions created by the variability of performance. Thus the gains from adopting performance related pay are higher in indexed contracts and indexed contracts are more likely to adopt performance related pay. In a detailed econometric analysis of Canadian Collective Bargaining Agreements, considerable evidence is provided for the predictions of this model. Indexed contracts are indeed longer than others and more than twice as likely to adopt performance related pay.;Optimal rising health care costs. I show that the observed rise in the share of income allocated to health in the OECD countries is an optimal response to the rise in income. The argument has two steps. (1) I provide both theoretical and empirical results that suggest that there may not be diminishing returns in the production of life expectancy. (2) This implies that if life time utility is the product of life expectancy and per-period utility from consumption, then the marginal utility of health expenditure does not decline. Thus if the marginal utility of consumption declines, it is optimal to spend a rising share of GNP on health.;The two chapters are related in the following sense: When contracts are indexed, the optimal contract length rises and therefore the gains from reducing distortion costs further by adopting performance related pay also rise. Similarly when some diseases are cured, life expectancy rises and this in turn raises the opportunities for benefiting from newly developed cures. Thus in each instance innovations (improvements) raise the gains from further innovations. Thus there are complementarities in these innovations and agents should make several if they make any.
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