Chap9 Slide UE

Labor Economics
Chapter 9
Equilibrium unemployment
Pierre Cahuc, Stephane Carcillo and Andre Zylberberg
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In this chapter, we will:
I See that the industrialized countries have evolved in very

different directions with respect to unemployment
I Observe the magnitude of job creation, job destruction, and
worker flows
I Discover the meaning and the importance of the Beveridge
curve
I Analyze the functioning of the labor market as a matching
process between vacant jobs and job seekers
I Think about the efficiency of a labor market with trading
externalities
I Analyze the dynamics of vacancies and unemployment
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Table of contents
Facts
The competitive model with labor adjustment costs
The efficiency of the competitive equilibrium
The limitations of the competitive model
The matching model
The matching function and the Beveridge curve
Wage bargaining and the adjustment lag of capital
Labor market equilibrium
The efficiency of market equilibrium
Trading externalities and social optimum
Is labor market equilibrium necessarily inefficient?
The investment decision
Unemployment fluctuations
The dynamics of the vacancies and unemployment
The unemployment volatility puzzle
Summary and conclusion
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Introduction (1)
I In every developed country, jobs and manpower have

movements of considerable magnitude
I All developed economies are affected by unemployment in
various ways
I Differences in the profile of unemployment are largely
explained by different approaches in managing these ebbs and
flows
I For a worker, the search for a job that fits her requirements
and skills is a process that often takes a lot of time, and so
does a firm in selecting individuals
I Imperfections in the available information entail frictional
unemployment which is characterized by the simultaneous
presence of unemployed persons and vacant jobs
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Introduction (2)
I The level of unemployment depends on the processes of job

destruction and creation
I It also depends on institutional factors which influence the
length of an unemployment spell and the hiring process of
firms
I In this chapter, we envisage the hiring process as a
phenomenon of matches between employers and workers
I This approach makes it possible to analyze the determinants
of unemployment in a dynamic environment where jobs are
created and destroyed continually and in which there are
transaction costs attached to reallocating employment
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Facts
The matching model
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Unemployment, employment, and participation (1) -
Different experiences of unemployment
I Unemployment is characterized by 3 conditions:

I persons who are without work
I persons who are available for work
I persons who are seeking work
I There exists a great diversity in the experiences of
unemployment by countries
I It is generally observed that countries with high rates of
employment and participation have lower rates of
unemployment than others
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I Figure 9.1 shows the existence of a decreasing relation

between the unemployment rate and the rate of employment
I The employment rate is thus a relevant indicator of the
abundance of jobs
I Figure 9.2 reveals a decreasing relation between participation
rate and unemployment rates
I The overview of unemployment experiences suggests that high
unemployment is caused by insufficient job creation
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Changes in employment, unemployment, and labor force
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Unemployment, employment, and participation (6) - The
relation between unemployment, employment and the labor
force
I Figure 9.3 shows that the unemployment rate has evolved very
differently in Japan, in continental Europe and in the United
States
I In the continental Europe, unemployment rate was low until
the 1970s and rose steadily until the late 1990s
I Japan had a stable unemployment rate until the 1990s and it
rose between 1994 and 2001
I Accounting equality:
Nt t = Lt + Ut
I Nt designates the population of working age
I Lt the employment level
I Ut the number of unemployed
I t the participation rate at period t
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force
I The unemployment rate is defined by ut Ut /(Lt + Ut ).
Thus, we have:
Lt
Nt t =
1 ut
I Taking this equation in logarithm at dates t and t 1, and
using the approximation Lim ln x = x 1, we get:
x 1
Nt t Lt ut
+ = +
Nt 1 t 1 Lt 1 1 ut 1
I We can deduce the variations in the unemployment rate:
Nt t Lt
ut ' +
Nt 1 t 1 Lt 1
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force
I This decomposition shows that variations in the

unemployment rate come from changes in:
1. The employment rate
2. The size of the working-age population
3. The participation rate
I Thus, it is entirely possible that unemployment rate falls
without a rise of employment
I Figure 9.4 shows that the growth of unemployment in Europe
is not the upshot of this scenario
I Contrary to the United States, other countries experienced
relatively slow rates of expansion of the labor force
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force
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chronic weakness of job creation in continental Europe
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I Figure 9.4 to 9.7 present some striking facts:

I The strong expansion of the labor force in the United States is
the result of a rise in the participation rates and a more
sustained growth in the size of the working age population
I European countries poor performance in job creation leads to
low employment rates
I All these elements suggest that the United States has a better
capacity to create jobs than other compared countries
I To sum up, during last 30 years, European countries present a
structural incapacity to create enough jobs. The weakness of
job creation has been reflected in the rise of unemployment
level
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long-term unemployment
I Figure 9.8 shows that the long-term unemployed represent

more than 50% of overall unemployment for most European
countries (Belgium, Estonia, France, Germany, Greece, Ireland,
Italy, Portugal, and Slovakia)
I The share of long-term unemployment is 15 points lower in the
US and Japan and 30 points lower in the Nordic European

countries
I Long term unemployment influences the employability of workers
I In countries where the unemployment rate is high, the long-term
unemployment rate is strong
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long-term unemployment
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Jobs flows (1)
I Net variations of employment are equal to the difference

between job creations and job destruction
I It is also equal to the difference between workers entries into
and exits out of employment:
Net employment change = Creations
| {zDestructions}
Job flows
= Hirings Separations
| {z }
Worker flows
I Examination of the data reveals that the labor market is

characterized by intense reallocation of jobs and workers
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Jobs flows (2) - Job creation and destruction
I Job creation represents the sum of job gains measured at the

firm level (or establishment level according to the studies)
over one year, due to the opening of new production units and
the expansion of jobs within existing workplaces
I Job destruction represents the sum of job losses resulting from
the closing of production units and contractions in the
number of jobs in units
I The job reallocation is equal to the sum of job creation and
job destruction
I The net employment growth is equal to the difference
between these two quantities
I The excess job reallocation is the difference between job
reallocation and net employment growth
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I Table 1 shows wide variations in job creation and destruction

flows
1. Countries with low excess reallocation have lower shares of
temporary employment, while low EPL tends to be associated
with higher reallocation rates
2. Another dimension which may explain disparities is the
distribution by size of firms. Countries with low excess
reallocation have lower shares of temporary employment, while
low EPL tends to be associated with higher reallocation rates
I For all countries, net employment growth is always much
smaller than job creation or destruction
I Job reallocation belongs to a different order of magnitude
than net employment growth i.e. the excess job reallocation is
considerable
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Job Job Job Net Excess job

Country (period)
creation destruction reallocation Employment reallocation
Argentina (95-02) 12.7 10.7 23.4 2.0 21.4
Brazil (96-01) 16.1 12.9 29.0 3.2 25.8
Chile (79-99) 11.6 11.3 22.8 .3 22.5
Colombia (82-98) 10.5 10.0 20.5 .5 20.0
Estonia (95-01) 13.3 12.0 25.3 1.3 24.0
Finland (88-98) 13.8 14.0 27.8 -.2 27.6
France (99-00) 12.0 8.3 20.3 3.7 16.6
Germany (77-99) 8.4 7.1 15.5 1.3 14.2
Hungary (92-01) 13.3 11.2 24.5 2.1 22.4
Italy (86-94) 12.3 10.2 22.5 2.1 20.4
Latvia (96-02) 15.7 10.8 26.5 4.9 21.6
Mexico (85-01) 16.9 12.0 28.9 4.9 24.0
Portugal (83-98) 12.5 10.7 23.3 1.8 21.4
Slovenia (92-01) 9.0 8.1 17.1 .9 16.2
United Kingdom (80-98) 11.5 12.6 24.2 -1.1 23.1
United States (88-97) 12.5 10.0 22.5 2.5 20.0
Table 1: Job creation and destruction flows.

Annual average rate as a percentage of total employment, all sectors of the economy.
Note: * Manufacturing only for Brazil, Chile, Colombia, and the U.K.. West Germany
for Germany. Mostly private sector for Germany, Portugal, and the U.S.
Source: data from Haltiwanger et al. (2010), see their table A.1 for exact sources;
except for France where data is from Picart (2008, table 2)
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I The job creation and destruction presented in table 1 do not

include job reallocations that take place within individual firms
I Studies that have attempted to assess job reallocations within
workplaces suggest that this factor is not negligible
I Hamermesh et al. (1996) find that reorganizations within
firms explain 11% of overall job reallocations
I Lagarde et al. (1995) estimate that job reallocations within
firms in France represent almost half of all job reallocations
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Jobs flows (6) - The extent of within-sector reallocation
Job movements most frequently take place within the same sector,
rather than between different sectors.
I The extent of job reallocations due to between-sector
movements can be measured by:
S
RE = |Vns | |Vn |
s =1
I S designates the number of sectors
I Vns designates the net employment growth in a given sector s
I Vn designates the net employment growth in the economy as a
whole
I The sum of excess job reallocations within each sector can be
measured by:
S
RI = (Ts |Vns |)
s =1
I Ts is the job reallocation in sector s
I Between-sector reallocations are never more than a small
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Jobs flows (7) - The extent of within-sector reallocation
Country Period Number of sectors RE / ( RI + RE )

Germany 83-90 24 0.03
United States 72-88 980 0.14
France 84-88 15 0.06
France 84-91 600 0.17
Italy 86-91 28 0.02
Sweden 85-91 28 0.03
Table 2: Fraction of job reallocation accounted for by employment shifts
between sectors.
Source : Davis and Haltiwanger (1999a, table 5)
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Jobs flows (8) - Job creation and destruction over time
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Jobs flows (9) - Job creation and destruction over time
I Figure 9.9 shows that the rates of job creation and destruction
in the US from 1990 to 2010 do not exhibit any upswing over
the period, rather we observe a slight declining trend
I Figure 9.9 also shows that job creation is strongly procyclical:
it falls during recessions
I However, job destruction is countercyclical: it rises during
recessions
I The rate of job reallocation is countercyclical since cycles are
marked by strong variations of jobs destroyed
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Worker flows (1) - Employment inflows and outflows
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I Figure 9.10 presents monthly movements of manpower in the

US for the period 1996-2003
I Around 15 million persons changed states or jobs, which
corresponds to 8% of the working age population
I Worker flows are different from job flows: in addition to
entries and exits, they include rotations in the same job
I In other words, a number of workers may follow one another
into and out of the same job
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I Table 3 portrays the flow of entries and exits from

employment for 26 OECD countries during the year 2011
I Worker flows are greater in size than job flows. The exit rate
from employment is almost twice as high as the rate of job
creation
I Table 3 also reflects different worker mobility form country to
country. Countries with low mobility are characterized by low
worker rotation
I So far, we have analyzed a static model of worker flows
I Variation in worker flows over the course of time determines
the dynamics of unemployment and employment
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Country Entry rate (hirings) Exit rate (separations)
Australia 23 24
Austria 16 16
Belgium 14 12
Canada 20 18
Czech Republic 12 11
Denmark 22 22
Finland 22 21
France 14 14
Germany 16 14
Greece 9 16
Hungary 14 13
Ireland 13 14
Italy 11 10
Korea 36 33
Mexico 26 25
Netherlands 17 4
Norway 16 15
Poland 14 13
Portugal 15 15
Slovak Republic 10 8
Spain 17 17
Sweden 21 18
Switzerland 18 16
Turkey 35 27
United Kingdom 15 14
United States 19 22
European Union (15 countries) 15 14
OECD (30 countries) 18 18
Table 3: Annual employment inflows and outflows.

Source: OECD Labor Force Statistics Database.
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Worker flows (5) - On displacement
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Worker flows (6) - On displacement
I Exits from employment comprise quits, the ending of

short-term contracts, retirements, firings for cause, and job
loss through no fault of the employee
I Displaced workers are defined as persons who lost or left jobs
because their company closed or moved, and so there was
insufficient work for them to do, or their position or shift was
abolished
I Job displacements are counted as job separations from firms
I Figure 9.12 reproduces the values of the displacement rate for
several industrialized countries
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Worker flows (7) - Unemployment inflows and outflows
I Figure 9.13 displays the rates of entry and exit from

unemployment for 14 industrialized countries
I The rates of exit from unemployment are much higher than
the rates of entry into unemployment
I Figure 9.13 suggests that continental European labor markets
are sclerotic, to the extent that they display much lower rates
of reallocation of labor
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Worker flows (8) - Unemployment inflows and outflows
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Worker flows (9) - Worker reallocation over time
I Figure 9.14 shows that separations, layoffs, and quits fluctuate

over the course of the business cycle
I In the United States, layoffs are countercyclical as firms have
a tendency to lay more employees off during recessions
I Variations in quits are of the same order of magnitude as
variations in layoffs
I Just like job creations, hirings are generally procyclical
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Worker flows (10) - Worker reallocation over time
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Worker flows (11) - Unemployment dynamics
I Variation in worker flows over the course of time determines
the dynamics of unemployment and employment
I The employment rate may rise with an increase in entries into
unemployment and a decrease in exits from unemployment
I Shimer (2012), utilizing data that cover the period 1948-2010
for the US, finds that the job-finding probability accounted for
three quarters of the fluctuation in the unemployment rate,
and the employment exit probability for one quarter
I For continental European and Nordic countries, Elsby et al.
(2013) estimate that 55% of overall variation in the
unemployment rate is accounted for by variation in the outflow
rate and consequently 45% by variation in the inflow rate
I As a consequence, the outflows from unemployment increase
as the economy recovers
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Worker flows (12) - Beveridge curve
I Beveridge (1944) proposed to use the relationship between

vacant jobs and the unemployment level to assess the extent
of worker reallocation
I The Beveridge Curve illustrates this linkage between the
unemployment rate u and the vacancy rate v
I It illustrates the simultaneous presence of unemployed persons
and vacant jobs due to:
I Mobility costs associated with location and skill
I Imperfect information
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The Beveridge curve in the United States

I Figure 9.16 shows that the unemployment rate rises and the
vacancy rate falls during the Great Recession in 2008-2009
I During the recovery phase, more vacant jobs than before were
required to reach the same unemployment rate. Thus, it is
possible that the BC has shifted toward the right
I This shift represents a reduced efficiency of the matching of
worker to jobs since the Great Recession entailed reallocation
shocks replacing low-skilled layoffs by more skilled workers
I It is also possible that the BC has not shifted but rather that
the recovery phase is situated on a counterclockwise transitory
path
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Facts
The matching model
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The competitive model with adjustment costs (1) - Job
reallocation and labor market equilibrium
I A simple approach to understand the consequences of labor

market friction is to introduce adjustment costs of
employment into the perfect competitive model
I We assume that the labor force is composed of a large
number of individuals having different reservation wages
I Each worker can produce an exogenous quantity y of goods.
The production of a firm having L workers is equal to yL
I An exogenous proportion q of jobs is destroyed at every
instant. If the firm wants to keep its L workers, it has to bear
an adjustment cost equal to C (qL) with C 0 > 0 and C 00 < 0
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I Let w stand for the current wage. The instantaneous profit is:
= Ly [wL + C (qL)]
I Deriving the expression of the instantaneous profit with
respect to employment yields:
y = qC 0 (qL) + w
I It shows that the marginal productivity y of labor is equal to
the marginal adjustment cost of a job plus the wage at the
optimum
I A rise in the rate q of destruction increases marginal
adjustment costs and thus increases the total marginal cost of
a job, and so entails a reduction of demand for labor
I Conversely, an increase in marginal productivity shifts the
demand curve upward
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I At equilibrium, wage w and employment L are given by:
y = qC 0 [qNH (w )] + w , L = NH (w )
I Where H is the cdf of reservation wages

I Although certain individuals are not employed, there is no
unemployment in this model since every person who wants to
work at the current wage can do so
I In this model, unemployed individuals simply prefer to remain
outside the labor market and do not look for a job
I In sum, the competitive model allows us to understand certain
determinants of employment. However, it does not help in
analyzing unemployment
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I A competitive market yields an efficient allocation of labor
resources
I The planners problem is:
Z +
max yNH (z ) C [qNH (z )] + N xdH (x )
z z
I The optimal productivity threshold, z, is given by:
y = qC 0 [qNH (z )] + z
I The optimal productivity threshold is identical to the

equilibrium wage w
I The competitive equilibrium is a social optimum
I Job destruction exerts a negative effect on the stock of jobs in
the presence of labor turnover costs, but it entails no
inefficiency in the allocation of resources
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Three limitations are highlighted:
1. Empirical studies show that productivity shocks have much
more effect on employment than on wages
I The competitive model presented contradicts this because the
elasticity of labor supply is small
2. The hypothesis of perfect competition does not explain

inefficiencies arising from the labor market
I The presence of unemployed persons and vacant jobs stem
from the imperfect information and mobility costs
3. The competitive model also postulates a mode of wage

formation that ignores the institutional characteristics of labor
markets
I Wage bargaining and manpower management policies have a
preponderant influence on levels of remuneration
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Facts
The matching model
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The matching model
The matching model is a simple model in which transaction costs

explain the simultaneous existence of vacant jobs and unemployed
persons.
I Wage results from a bargaining process between employers
and workers
I The matching function sums up, at the aggregate level, the
outcomes of encounters between job seekers and vacant firms
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The matching function and the Beveridge curve (1)
I In practice, job search procedures are characterized by a large

number of frictions, such as the mismatch between certain
vacant jobs and the skills of workers
I To face these frictions, employers and job seekers adopt
search strategies which take time and often have high costs
I The matching function goes straight to an aggregate level and
does not take into account the diversity of individual actions.
It describes how the flow of hires, M, is linked to the stock of
vacant jobs, V , and the number of persons in search for work,
D
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The matching function and the Beveridge curve (2) -
Microeconomic foundations
I An aggregate matching function can be obtained by using a

model with urns and balls
I Urns designate vacant jobs
I Balls designate job applications
I A job seeker knows the locations of the vacant jobs and she
sends ei applications randomly
I For any vacant job, the probability of receiving the application
of an individual i is ei /V
I The number of hires M is:
" #
i =D ei
M = V 1 1
V
i =1
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I Approximating 1 (ei /V ) by exp [(ei /V )] , the matching

function is:

e D
M = M (V , e D ) = V 1 exp
V
I The presence of the value e of the average search intensity
justifies inclusion, in the estimates of the matching function,
of all the variables that may affect job search effort
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I Ranking models assume that firms have preferences among

the applications they receive
I For example, if firms give priority to the short-term
unemployed, the average probability of finding a job diminished
with the incidence of long-term unemployment
I In stock-flow matching models, the existence of stocks of
vacant jobs and unemployed persons reflects an inadequate fit
between the characteristics of vacant jobs and those of job
seekers perfectly known
I Job search process will privilege new inflows of applications
over stocks already examined
I Coles and Smith (1998) find that only new flows of vacant
jobs significantly increase the hazard rates of the long-term
unemployed
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The matching function and the Beveridge curve (5) - The
properties of the matching function
I The aggregate matching function, denoted by M (V , D ),

represents the instantaneous flow of hires at a given date. The
hires increase with the number of job applicants or vacancies
I It is often assumed that only unemployed persons are job
applicants, U = D
I It is often assumed that the matching function exhibits
constant return to scale
I Under these assumptions, the probability of filling a vacant
job is:
M (V , U ) V
= M (1, U/V ) m( );
V U
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I is an indicator of the tightness of the labor market. One
has:
U2 U
m0 ( ) = 2 MU0 (1, ) < 0
V V
I Vacant jobs are filled at a rate that diminishes with the
tightness ratio
I The exit rate from unemployment also called the hazard rate
is also defined by:
M (V , U ) V M (V , U )
= = m( )
U U V
I Consequently, m ( ) is an increasing function of the market
tightness. Each unemployed person has a greater chance to
find a job when the vacancy increases
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I Trading externalities: the increase in the number of vacant

jobs diminishes the rate at which vacant jobs are filled and
increases the exit rate from unemployment
I It is in the interest of unemployed persons for firms to create
jobs, but in the interest of each firm for the number of
vacancies to be as low as possible
I Between-group externalities are positive, but within-group
externalities are negative, corresponding to congestion effects
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Some empirical elements
I Adopting a Cobb-Douglas form, the matching function can be:

1
Mt = At Vt Ut
I Parameter At represents the efficiency of the matching process
at period t
I The explanatory variables are the stocks of unemployed
persons (Ut ) and vacant jobs (Vt )
I Taking the logarithm,
ft = (1 ) ln t + at
I ft is the logarithm of the exit rate from unemployment
I t = Vt /Ut represents labor market tightness
I at designates the logarithm of the efficiency parameter
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Some empirical elements
I Usually the estimation uses simple OLS regression procedures

I Barnichon and Figura (2011) find that the composition of the
unemployment pool explains an important part of the
efficiency of the matching process
I Borowczyk-Martins et al. (2013) noted that OLS regressions
are biased since the decision to post a job vacancy depends on
the efficiency of the matching process
I Firms may have an incentive to create more vacant jobs when
the efficiency of the matching process improves
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Equilibrium of flows and the Beveridge curve
I Labor market tightness and the rate of job destruction
condition the dynamics of unemployment
I U denotes the stock of unemployed persons
I L employment and N the size of the labor force
I The labor force grows by quantity N
I m ( )U denotes the number of unemployed persons who find
a job
I The variation U of unemployment is:
U = N + qL m ( )U
I The law of motion of the rate of unemployment is:
u = q + n [q + n + m ( )] u
I The stationary value of the unemployment rate, u = 0 gives:
q+n
u= (8)
q + n + m ( )
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Equilibrium of flows and the Beveridge curve
I Equation (8) describes a relationship between the

unemployment rate u and the vacancy rate v . It expresses the
equilibrium of worker flows between employment and
unemployment
I In the plane (v , u ), this relationship yields the Beveridge curve
I Moreover, the position of the Beveridge curve reflects the
efficiency of the matching technology, the more this curve lies
farther out from the origin, the more inefficient this
technology is
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The behavior of firms and workers (1)
I There are two goods in the economy: labor and a good

produced by the firms and consumed by individuals
I The labor is the sole factor of production. The good produced
by the firms is the numeraire
I In the basic matching model, each firm has one job that can
be either vacant or filled. When filled, it enables the
production of an exogenous quantity y of the good per unit of
time
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The behavior of firms and workers (2) - Firms
The expected profit from a filled job

I A filled job is liable to fall vacant with an exogenous
probability qdt, over a small interval of time dt
I The real interest rate r is exogenous
I The wage is denoted by w
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I The expected profit from a filled job satisfies:

1
e = [(y w )dt + qdtv + (1 qdt )e ]
1 + r dt
I Where v denotes the value of a vacant job

I Also written:
r e = y w + q ( v e )
I This portrays the equality of the returns of different assets in

a perfect financial market
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The profit expected from a vacant job
I The costs of a vacant job per unit of time are denoted by h.
These costs represent the expenses incurred in holding the
position open and looking for an employee with the right skills
to fill it
I Since vacant jobs are filled at rate m ( ), the expected profit
satisfies:
1
v = {hdt + m( )dte + [1 m( )dt ] v }
1 + r dt
I Or again,
r v = h + m ( )(e v )
I This equates the instantaneous return of the unfilled job
asset in the financial market to its return in the labor market,
which comprises the instantaneous cost and the average gain
associated with a change of state
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Labor demand
I As long as the expected profit from a vacant job remains
positive, new entrepreneurs will create jobs
I When v = 0, the two previous equations give:
h y w
= (12)
m( ) r +q
I The left side represents the average cost of a vacant job, and
the right side is the expected profit from a filled job
I Equation (12) signifies that at free entry equilibrium, the
average cost of a vacant job must be equal to the profit
expected from a filled job
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I Equation (12) defines a decreasing relation between the wage

and the labor market tightness, which is analogous to labor
demand in the neoclassical theory of the firm
I It reveals that a rise in wage w degrades the profit of a filled
job
I Since the expected profit of a filled job equals the average
cost of a vacant job, entrepreneurs react to a decrease in the
expected profit of filled jobs by posting fewer vacant jobs
I In the matching model, a strictly positive profit from filled
jobs is indeed required if employers are to have an interest in
posting vacant slots
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The behavior of firms and workers (7) - Workers
I The labor force is composed of N individuals, whose lifespan

is infinite. An employed worker has an expected utility Ve ,
and the unemployed one, an expected utility Vu Ve
I When employed, she produces a quantity y and gets a real
wage w . She also risks losing her job at rate q
I The expected utility of an employee at stationary equilibrium
is:
rVe = w + q (Vu Ve )
I The instantaneous gain of a job seeker is denoted by z < y
I Since the exit rate is m ( ), the expected utility of an
unemployed person is:
rVu = z + m ( )(Ve Vu )
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Wage bargaining (1) - Surplus sharing
I When a worker and a vacant job come together, the employer

and the potential employee bargain over the wage
I The wage bargaining outcomes is described by a surplus
sharing rule
I The surplus is defined by the sum of the rents that a filled job
procures
I Rent represents the difference between what individuals obtain
through the contractual relationship and what the best
opportunity outside the contract would bring them
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I The surplus is:
S = Ve Vu + e v
I The result of the negotiation:
Ve Vu = S and e v = (1 )S
I Where is the bargaining power of the worker
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A bargaining game
I The bargaining unfolds as a two-stage game with the
following characteristics:
1. Two players propose a contract that stipulates a wage to be
paid in the future small interval of time dt
2. If one of the two players has refused to sign the contract
proposed in previous stage, the worker makes a new offer with
probability , and the employer makes an offer of the same
kind with the complementary probability (1 )
I If the worker makes the offer, in stage 2 the employer obtains
a gain of v , and the worker takes the whole surplus
I If the employer makes the offer, the worker obtains Vu , and
the employer takes the whole surplus
75 / 130
I In the first stage, the worker knows that her expected utility
will amount to Vu + S. Symmetrically, the employer knows
that his expected profit will be equal to v + (1 )S
I In consequence, it makes no difference to either player
whether they sign a contract at stage 1 stipulating an
expected utility Ve equal to Vu + S for the employee, and an
expected profit e equal to v + (1 )S, for the employer
I If we assume the presence of a cost attached to going to stage
2, the bargaining game possesses a single equilibrium,
corresponding to the immediate agreement of a surplus
sharing contract
I Actually, we can construct a lot of bargaining games resulting
in different interpretations of parameter , which depends on
the preference of the players for the present and their degree
of risk aversion
76 / 130
The negotiated wage

I By adding the expressions of expected profit and expected
utility, we can obtain a simple expression of the surplus:
y r (Vu + v )
S=
r +q
I Moreover, definitions of the profit and utility expected from a
filled job can be written:
w rVu y w r v
Ve Vu = and e v =
r +q r +q
77 / 130
I At free entry equilibrium, the negotiated wage is:
w = rVu + (y rVu )
I When the employee has all bargaining power, ( = 1), then

she garners all of production y
I If the employer possesses all the bargaining power, ( = 0),
the wage w is then equal to rVu and we have Ve = Vu
I In the intermediate case, (0 < < 1), the wage negotiated is
a convex combination of the value y of the production and of
the reservation wage rVu
78 / 130
Wage bargaining (7) - The wage curve
I Using the definitions of the expected utility, the negotiated
wage, the results of negotiation relative to the power of
worker and the surplus, we obtain:
z (r + q ) + y m ( )
rVu =
r + q + m ( )
I Then, the negotiated wage obtained is:
[r + q + m ( )]
w = z + (y z ) ( ) (WC) with ( ) =
r + q + m ( )
I ( ) represents the actual weight of the employee in the
bargaining
I Since the exit rate m ( ) from unemployment increases with
labor market tightness , ( ) increases with too
I Therefore, the negotiated wage increases with the labor
market tightness
79 / 130
I The actual weight function is decreasing with the exit rate q

and increases with the intrinsic weight of the employee in
the bargaining
I Wage curve denoted by (WC ) designates the curve that
precisely encapsulates the outcome of this bargaining
I For a given number of vacant jobs, it defines a decreasing
relation between wages and the stock of unemployed persons,
which is equivalent to a rising relation between wages and
employment
80 / 130
I Empirical elements relating to bargaining power

I Abowd and Lemieux (1993) have shown that workers capture
30% of the rent obtained by firms protected from competition
I Van Reenen (1996) has studied the share-out of rents created
by innovation, and obtained that 29% of rent was captured by
employees
I Manning (2011) presents the principal estimates of parameter
and finds that large variations appear linked to labor market
institutions. But in the majority of studies, the estimate proves
to be different from zero
I In sum, these results suggest that workers capture a portion of
the rent of jobs
81 / 130
Labor market equilibrium (1) - The determination of
wages, tightness, and the unemployment rate
I In the matching model, labor demand, the wage curve and the
Beveridge curve allow us to characterize completely the
equilibrium values of the unemployment rate, wages and labor
market tightness
I In this model, the wage curve takes the place of the supply
curve of the competitive model. Hence, the equilibrium values
of the labor market tightness and the wage correspond to the
coordinates of the intersection of the wage curve with labor
demand
82 / 130
I Using the free entry condition (12) and the wage curve (WC),
we get:
(1 )(y z ) h
=
r + q + m ( ) m( )
I The left side of this relation represents the value of the profit
expected from a filled job and the right side represents the
average cost of a vacant job
83 / 130
84 / 130
85 / 130
I Figure 9.22 represents labor market equilibrium in the plane

(v , u )
I Knowing the equilibrium value of the tightness ratio, the
equilibrium value the unemployment rate is equal to the
abscissa of the intersection of the Beveridge curve (BC ) and
the line that starts from the origin with slope
86 / 130
Labor market equilibrium (6) - Comparative statics
The growth of the labor force

I A rise in the growth rate n of the labor force shifts the
Beveridge curve upward without changing the (WC ) and
(LD ) curves
I The wage remains constant, but unemployment mounts
I This situation is equivalent to a deterioration of the matching
process
87 / 130
Bargaining power
I For a given value of , an increase in the employees
bargaining power pushes the equilibrium wage upward
I Since labor demand is unchanged, the rise in involves a shift
upward of the wage curve, which provokes a rise in the
equilibrium wage
I The number of vacant jobs will thus fall, which is equivalent
to a diminution of
I The Beveridge curve being independent of , unemployment
increases
Unemployment insurance benefits
I The effect of an increase in unemployment benefits is exactly
the same as that of an increase in . By improving the
expected utility of unemployed worker, it increases wage
pressure
I In total, unemployment increases. Yet, unemployment benefits
are also attended by an eligibility effect
88 / 130
Productivity
I A rise in individual productivity y increases the negotiated
wage but has an ambiguous effect on the equilibrium value of
tightness
I It arises from two effects:
I The rise increases the size of the pie to share between
worker and the firm. Consequently, both wage for worker and
profit for firm rises.
I An increase in wage drives a reduction of vacant jobs by firms
I An increase in profit gives an opposing incentive to increase it
I This ambiguity disappears if we differentiate the equation:
(1 )(y z ) h
=
r + q + m ( ) m( )
89 / 130
Productivity
I An increase in productivity has a positive effect on tightness
and reduces the unemployment rate
I But unemployment benefits are most often defined as a
fraction of past wages, and search costs certainly rise with the
cost of labor
I This signifies that the unemployment rate is affected by the
level of productivity in the short and medium term but
independent in the long term
90 / 130
The efficiency of the matching process

I Improved efficiency in the matching process increases the
probability of individuals returning to work. Consequently, the
expected utility of an unemployed person increases and so the
actual threat point of workers in wage bargaining
I In parallel, improved efficiency in the matching process
increases the probability of filling vacant jobs which lowers
their average cost and rises tightness
I In total, wages rise when the labor market tightness increases
I Finally, the unemployment rate falls since improved efficiency
in matching shifts the Beveridge curve downward
91 / 130
The job destruction rate

I A rise in the job destruction rate q is strictly equivalent to
lowering the efficiency of the matching process
The interest rate

I A rise in the interest rate decreases the surplus of filled jobs
I By depreciating the discounted value of future profits, it
reduces the incentive to post vacant jobs and so increases the
unemployment rate
92 / 130
Facts
The matching model
93 / 130
Trading externalities (1)
I In the matching model, the allocation of labor resources is

characterized by the presence of positive between-group
externalities and negative within-group congestion effects
I Every unemployed person would like to be the only person
searching for a job and have as many vacant jobs as possible,
while every employer would like to be the only one with
vacant positions and to be facing a wide array of job seekers
I There are congestion effects within each category and positive
externalities between the categories
I In a social optimum where social planner internalizes
externalities, these two effects would be blended
94 / 130
Trading externalities (2)
I In the decentralized equilibrium of the matching model with

wage bargaining, individuals do not internalize these
externalities
I The decentralized equilibrium of the labor market is generally
inefficient, except for a particular situation that verifies the
Hosios-Pissarides condition
I Under the hypothesis of directed search, where workers can
orient their job search as a function of the wages offered by
firms, the competition in which firms engage to attract
workers restores the efficiency of the decentralized equilibrium
95 / 130
The social optimum (1) - A useful particular case
I The planners criterion corresponds to the discounted value of

production per capita, since the marginal utility of a unit of
output is independent of the level of income and so is
identical for employers, employees, and unemployed
I Total instantaneous production is:
= yL + zU hV
I hV designates the costs linked to the existence of vacant jobs
I z represents an indicator of the return to leisure or to domestic
production
I yL production of employees
I The expression of output per capita is:
= y (1 u ) + zu hu
96 / 130
The social optimum (2) - A useful particular case
I Let us assume that r = 0, so that the planner maximizes
output per capita:
q
max = y (1 u ) + zu hu s.t. u =
{,u } q + m ( )
I FOC gives:
[1 ( )](y z ) h m0 ( )
= and ( ) = (24)
q + m ( ) ( ) m( ) m( )
I is the elasticity of the matching function with respect to the
unemployment rate
I When r = 0, the decentralized equilibrium coincides with the
social optimum if and only if = ( )
I This condition, known as the Hosios condition indicates
that only a value of employees bargaining power equal to the
elasticity of the matching function gives the right blend of
congestion effects and positive externalities
97 / 130
The social optimum (3) - The general case
I When r > 0, the social planner must now take into account
losses from the inertia present in certain variables, such as
unemployment rate
I The planners problem becomes:
Z +
max e rt dt
0
I subject to constraint:
u = q (1 u ) m ( )u
I The Hamiltonian of the planners problem is:
H = y (1 u ) + zu hu e rt + q (1 u ) m ( )u

I FOCs are given by:

H H
=0 and =
u
98 / 130
The social optimum (4) - The general case
I Differentiating the Hamiltonian with respect to , we get:
he rt = m ( )[1 ( )]
I The transversality condition is written: lim u = 0
t
I If we now derive the Hamiltonian with respect to u, we get:
(z y h )e rt [q + m( )] =
I After several rearrangements, the equation giving the optimal
value of labor market tightness is:
[1 ( )](y z ) h
=
r + q + m ( ) ( ) m( )
I Comparison to the value of labor market tightness at
decentralized labor market equilibrium shows that this
equilibrium coincides with the social optimum if Hosios
condition is satisfied
99 / 130
Is labor market equilibrium necessarily inefficient (1) - A
model with directed search and wage posting
I In the matching model with wage bargaining, the inefficiency

of decentralized equilibrium comes from the absence of
mechanisms giving agents an incentive to take into account
the externalities linked to their decisions
I These mechanisms can exist with other wage setting rules
I Moene (1997) assumes that wages are no longer bargained
over, but fixed by employers
I There are a large number of labor pools where the mobility
and information are perfect
I The number of hires is determined by a matching function
I Employers offer the same wage in each labor pool, which is
not renegotiable
100 / 130
Is labor market equilibrium necessarily inefficient (2) - A
model with directed search and wage posting
I The expected utility of a person employed in labor poor i is:
rVei = wi + q (Vu Vei )
I The expected utility of a unemployed person is:

rVu = z + i m (i )(Vei Vu ) i
I Eliminating Vei between these last two equations gives,
(rVu z )
i m ( i ) = (r + q ) (32)
wi rVu
I This last equation reveals the implications of the competition
among entrepreneurs to attract workers. They offer the same
expected utility to those in search of work in two ways:
opening few jobs against a high wage or opening many jobs
against low wage
101 / 130
Is labor market equilibrium necessarily inefficient (3) - The
efficiency of decentralized equilibrium
I The optimal strategy for the entrepreneurs consists of offering
a wage so as to maximize the expected gain from vacant jobs
I The expected gain vi from an unfilled job, and from a filled
one are:
r vi = h + m (i )(ei vi )
r ei = y wi + q (vi ei )
I The expression of the profit expected from a vacant job is:

h(r + q ) + m(i )(y wi )
vi =
r + q + m ( i )
I Deriving (32) gives:
i i i m 0 ( i )
= ; ( i )
wi [1 (i )] (wi rVu ) m ( i )
102 / 130
Is labor market equilibrium necessarily inefficient (4) - The
efficiency of decentralized equilibrium
I Using this last equation and free entry condition, the FOC
condition of the entrepreneurs problem in pool i arrives at:
wi = rVu + (i )(y rVu )
I Comparing this result to the negotiated wage in the basic

model shows that the mode of wage setting entails at
equilibrium the Hosios condition and so ensures the efficiency
of decentralized equilibrium
I This example suggests that competition among firms can
restore the efficiency of market equilibrium
103 / 130
Is labor market equilibrium necessarily inefficient (5) -
When union power leads to efficient allocation
I Different organization of the labor market also leads to an

efficient allocation
I A union setting wages chooses an efficient allocation if its
objective is to maximize the expected utility of the
unemployed. Maximization of the expected utility of an
unemployed person gives the social optimum
I The inefficiency of decentralized equilibrium is caused by the
fact that the economy does not comprise enough markets
capable of giving individuals the right incentives to internalize
the externalities
104 / 130
Investment and employment
I Up to now, it has been assumed that labor productivity was

exogenous. Actually, labor productivity is itself conditioned by
capital
I Taking capital into account leads to use of a large-firm
which comprises many wage earners and so manipulates their
number to influence wages
I This mechanism modifies labor demand and investment
behavior in firms
105 / 130
The investment decision (1) - The problem of the firm
I Decisions unfold in the following order:
I The firm decides on its hires
I The employer negotiates over wages with each worker. Capital
is chosen simultaneously with the wage bargaining
I We assume that there exists a capital market in which the firm
can buy and sell without delay
I With denoting Ii the instantaneous investment of firm and
the rate of depreciation of capital, the problem of the firm is:
Z +
maxi = [F (Ki , Li ) wi Li hVi Ii ] e rt dt
Vi ,Ii 0
I Subject to:
L i = m ( )Vi qLi
K i = Ii Ki
106 / 130
The investment decision (2) - The optimal solution
I The Hamiltonian of this problem is:
H = [F (Ki , Li ) wi Li hVi Ii ] e rt + [m ( )Vi qLi ]
+ (Ii Ki )
I FOCs are given by:
H H
= 0 and = (42)
Ii Ki
H H
= 0 and = (43)
Vi Li
I To these equations must be added the transversality
conditions:
Lim Li = 0 and Lim Ki = 0
t t
107 / 130
The investment decision (3) - The optimal solution
I Using the equalities (42), we get:
FK (Ki , Li ) = r +
I Substituting this expression of into the second equation, we

get:
FK (Ki , Li ) = r +
I This equation expresses the usual equality between the
marginal productivity of capital and its user cost (r + )
I After several simple calculations, at equilibrium, we get:
h (r + q )
FL (Ki , Li ) = wi +
m( )
I This relation conveys that the marginal productivity of labor
must be equal to the wage plus the employment adjustment
costs at the optimum
108 / 130
The investment decision (4) - Wage bargaining
I In stage 2, each employee bargains over his wage individually

with the employer. The bargaining concerns the marginal
surplus created by each job
I The marginal job brings in an instantaneous profit equal to
FL (Ki , Li ) wi
I Since every job destroyed brings in zero profit, the value of a
marginal job in firm i is written:

1
i = {[FL (Ki , Li ) wi ] dt + [1 qdt ] i }
1 + r dt
F (K , L ) wi
i = L i i
r +q
I This expression is identical to that giving the value of a filled
job in the basic model
109 / 130
The investment decision (5) - Wage bargaining
I The hypothesis of constant returns to scale entails that the
marginal productivity of labor does not depend on employment
I Equality between the marginal productivity of capital and its
user cost show that the capital labor ratio k and the
negotiated wage w are the same in all firms
I FOCs entail:
f 0 (k ) = r +
h (r + q )
f (k ) kf 0 (k ) = w +
m( )
I The capital-labor ratio is completely defined by the user cost
of capital, and the marginal productivity of labor is defined by
knowledge of r and
I In sum, this matching model with large firms justifies and
clarifies the use of the simplified model. It enables to study
the impact of variation in the interest rate on unemployment
110 / 130
The adjustment lag of capital (1)
I In reality, capital is a variable that generally adjusts only after
a certain delay
I Therefore, capital is frequently considered as a predetermined
variable
I In this case, the marginal productivity of labor is no longer
constant but decreasing
I Stole and Zwiebel (1996) elaborated an intrafirm bargaining
model to analyze this issue
I They found that the model yields no rent for employees
I It entails overemployment compared to a competitive market:
a firm with diminishing marginal productivity decreases the
bargained wage, and increases the marginal productivity of
labor by raising employment
I Cahuc et al. (2008) used the matching model for the same
issue and found that the strategic interactions involved in
intrafirm bargaining increase unemployment because the
distortions reduce profits and then job creation
111 / 130
Facts
The matching model
112 / 130
The dynamics of the vacancies and unemployment (1)
To this point, we have limited ourselves to the study of stationary
equilibrium.
Now, we study out-of-stationary-state dynamics, which allow us to
analyze the cyclical variation of unemployment and vacancies
I The expected utility of an employee and an unemployed
person are:
rVe = w + q (Vu Ve ) + V e
rVu = z + m ( )(Ve Vu ) + V u
I The terms V e and V u represent the time derivatives of Ve and

Vu
I Profits expected from a filled job and a vacant one are:
r e = y w + q ( v e ) +
e
r v = h + m ( )(e v ) + v
113 / 130
I The matching of an unemployed person to a vacant job yields

a surplus S and the time derivative of which is denoted by S:
S = Ve Vu + e v and S = V e V u +
e
v
I With the free entry condition the employees expected utility

and the profit expected from a filled job entail:
(r + q )S = S + y + V u rVu
I This differential equation describes the time path of the

surplus
114 / 130
I The wage bargaining outcome is similar to a surplus sharing

rule conditioned by the respective powers of the participants.
So we have:
Ve Vu = S and e v = (1 )S
I The profit expected from a vacant job yields the usual

equality between expected profit and average cost
I The second of the sharing rules entails:
h hm0 ( )
S= = S =
(1 )m ( ) (1 )m 2 ( )
115 / 130
I Bringing the values of S, S and (rVu V u ) into the
differential equation describing the time path of the surplus,
we have:
hm0 ( ) h [r + q + m ( )]
2
+ y +z = 0
(1 )m ( ) (1 )m ( )
I This differential equation completely characterizes the path of
labor market tightness. In the stationary state, it is identical
to the relation giving the stationary value of labor market
tightness
I Linearization of this differential equation in the neighborhood
of the stationary state yields:
m2 ( )
+ a = a with a = (r + q ) < 0
m0 ( )
116 / 130
I The general solution of this equation is of the form

= Be at + , where B is a constant
I Parameter a being negative, this result signifies that variable
immediately jumps to the stationary value. It arises from
the fact that opening up a vacant job is a forward-looking
decision taking into account expectations of future profit, and
contains no inertia factor
I In this model, all decisions of agents are directed toward the
future, hence, the negotiated wage is also a variable that
jumps instantaneously to its stationary value
117 / 130
I When labor market tightness has reached its stationary value

, the evolution of the unemployment rate becomes:
u + [q + n + m ( )]u = q + n
I This is a first-order linear differential equation where the
coefficient of u is positive
I The unemployment rate thus exhibits a monotonic
convergence to its stationary value
I Accordingly, the unemployment rate only gradually reaches its
stationary value
118 / 130
The unemployment volatility puzzle (1) - The puzzle
I According to Shimer (2005) the matching model cannot

reproduce unemployment dynamics well because any
productivity shock is immediately absorbed into the wage with
little effect on unemployment
I Given this, the matching model generates too much volatility
for the real wage and not enough for the unemployment rate
I He assumes that productivity y and the separation rate q
follow Markov processes
I The standard deviation of the tightness ratio is 10 times
weaker in the simulated model than in empirical data
I Moreover, the simulation of the model generates excessive
wage volatility
119 / 130
The unemployment volatility puzzle (2) - Solutions
The high value of nonmarket activity

I Hagedorn and Manovskii (2008) have proposed a model in
which the instantaneous income of the unemployed is high,
and in which they have little bargaining power
I The high value of the instantaneous income of the unemployed
is justified by the high value of non-market activity. In this
setting, the matching model reproduces the elasticity of the
exit rate from unemployment with respect to productivity
120 / 130
Wage rigidity
I Hall (2005) assumes that wages do not respond to aggregate
productivity shocks. It is then the level of employment that
absorbs these shocks
I Hall and Milgrom (2008) modify the threat point in Nash
bargaining by assuming that it is possible to prolong the
bargaining
I The threat is then no longer that the work relationship will be
broken off, but that time and production will be wasted
I They show that the value of the time and production wasted in
bargaining is less cyclical than the dissolution value of the job,
which corresponds to the discounted expected utility of
unemployed workers
I In consequence, in the model of Hall and Milgrom, the wage
reacts less to variations in productivity, which entails greater
volatility in the unemployment rate
121 / 130
I Kennan (2010) shows that small fluctuations in productivity

that are privately observed by the employers can give rise to a
kind of wage stickiness in equilibrium, and the informational
rents associated with this stickiness are sufficient to generate
relatively large unemployment fluctuations
I Pissarides (2009) has contested this hypothesis of wage
rigidity, stressing that hiring wages are flexible. He proposes
an alternative solution to the unemployment volatility puzzle
resting on the presence of fixed hiring costs rather than a
hypothesis of wage rigidity
122 / 130
Mover, Stayer, Starting Wage, Continuing Wage, and Fixed Hiring

Costs
I Pissarides noted that the wage stickiness is a property of the
average wage and that it does not apply to all wages
I When one concentrates on the wages of employees who are
starting new jobs (movers), wage stickiness looks a lot
different from what it does when we examine the wages of
those who remained in the same job for a while (stayers)
I Robin (2011) confirms this observation and indicates that
wage elasticities differ according to deciles
I For men, for instance, wage elasticity amounts to 0.92 for the
bottom decile and to around 0.40 in the middle of the
distribution
123 / 130
I Pissarides introduces fixed hiring costs in the matching model

I He calibrates the model and shows that the presence of fixed
hiring costs allows the model to reproduce the volatility of the
labor market tightness, the entry wages and the continuing
wages
124 / 130
Job heterogeneity and On-the-job search

I Menzio and Shi (2011) and Robin (2011) have studied the
consequences of aggregate productivity shocks in models with
heterogeneous jobs and on-the-job search
I Aggregate productivity shocks affect movement from job to
job and have a major impact on the destruction and creation
of low-productivity jobs
125 / 130
I Elsby and Michaels (2013) have studied labor market
dynamics with a model including large firms
I The model generates a large average surplus and a small
marginal surplus to employment relationships
I The small marginal surplus matches the volatility of the job
finding rate over the cycle
I The large surplus matches to the rate of entries into
unemployment
I Their model provides a coherent explanation for:
I The distribution of firm size and employment growth
I The amplitude and propagation of the cyclical dynamics of
worker flows
I The Beveridge curve relation between unemployment and
vacancies
I The dynamics of the distribution of firm size over the business
cycle
126 / 130
Facts
The matching model
127 / 130
Summary and conclusion (1)
I In most industrialized countries, job creation and destruction

are large-scale phenomena
I Total of these two flows amounts to between 15% and 30% of
overall employment every year
I Net employment growth is always much smaller than job
creation or destruction
I Movements in employment mostly take place within the same
sector
I Worker flows are systematically greater in size than job flows
I In the presence of transaction costs, reallocation of jobs and
workers can lead to the simultaneous presence of vacant jobs
and unemployed persons
128 / 130
I Matching process and the equilibrium of worker flows entail a

Beveridge curve that links the unemployment rate to the
vacancy rate
I Transaction costs in the labor market lie at the source of
exchange externalities, which entail that decentralized
equilibrium is generally inefficient when wages are bargained
over between employers and workers
I However, there also exists modes of wage determination such
as competition among entrepreneurs who post wages to
attract workers ensures the efficiency of decentralized
equilibrium
129 / 130
I The inefficiency of decentralized equilibrium is an open

question
I Shimer (2005) argued that the matching model cannot
reproduce unemployment dynamics well known as the
unemployment volatility puzzle
I He observes that any productivity shock is immediately
absorbed into the wage with little effect on employment
I Several solutions have been provided to reconcile the model
with the data: rigid wages, job heterogeneity, fixed cost of
recruitment, high value of non market activity
130 / 130

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Labor Economics

Pierre Cahuc, Stephane Carcillo and Andre Zylberberg

I See that the industrialized countries have evolved in very

I In every developed country, jobs and manpower have

I The level of unemployment depends on the processes of job

I Unemployment is characterized by 3 conditions:

I Figure 9.1 shows the existence of a decreasing relation

I This decomposition shows that variations in the

I Figure 9.4 to 9.7 present some striking facts:

I Figure 9.8 shows that the long-term unemployed represent

US and Japan and 30 points lower in the Nordic European

I Net variations of employment are equal to the difference

I Examination of the data reveals that the labor market is

I Job creation represents the sum of job gains measured at the

I Table 1 shows wide variations in job creation and destruction

Job Job Job Net Excess job

Table 1: Job creation and destruction flows.

I The job creation and destruction presented in table 1 do not

Country Period Number of sectors RE / ( RI + RE )

I Figure 9.10 presents monthly movements of manpower in the

I Table 3 portrays the flow of entries and exits from

Table 3: Annual employment inflows and outflows.

I Exits from employment comprise quits, the ending of

I Figure 9.13 displays the rates of entry and exit from

I Figure 9.14 shows that separations, layoffs, and quits fluctuate

I Beveridge (1944) proposed to use the relationship between

The Beveridge curve in the United States

I A simple approach to understand the consequences of labor

I Where H is the cdf of reservation wages

I The optimal productivity threshold, z, is given by:

I The optimal productivity threshold is identical to the

2. The hypothesis of perfect competition does not explain

3. The competitive model also postulates a mode of wage

The matching model is a simple model in which transaction costs

I In practice, job search procedures are characterized by a large

I An aggregate matching function can be obtained by using a

I Approximating 1 (ei /V ) by exp [(ei /V )] , the matching

I Ranking models assume that firms have preferences among

I The aggregate matching function, denoted by M (V , D ),

I Trading externalities: the increase in the number of vacant

I Adopting a Cobb-Douglas form, the matching function can be:

I Usually the estimation uses simple OLS regression procedures

I Equation (8) describes a relationship between the

I There are two goods in the economy: labor and a good

The expected profit from a filled job

I The expected profit from a filled job satisfies:

I Where v denotes the value of a vacant job

I This portrays the equality of the returns of different assets in

I Equation (12) defines a decreasing relation between the wage

I The labor force is composed of N individuals, whose lifespan

I When a worker and a vacant job come together, the employer

I The surplus is:

I The result of the negotiation:

I Where is the bargaining power of the worker

The negotiated wage

I At free entry equilibrium, the negotiated wage is:

I When the employee has all bargaining power, ( = 1), then

I The actual weight function is decreasing with the exit rate q