Matching

Theory
Nobel Prize
Winning Model -
2010
Prof. D. Joseph Anbarasu,
Bishop Heber College, Tiruchirappalli, India

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 Why Does Unemployment Remains High In Developed
Countries?

Contributors
• Peter Diamond, Dale
Mortensen and
Christopher Pissarides.
• Justin Lahart and David.
• Jonathan Cheng.

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 Dr. Peter A. Diamond, one of the world's leading economists, is
an Institute Professor at the Massachusetts Institute of
Technology.
He modeled how friction works

Dale T. Mortensen is the Ida C. Cook Professor of Economics at

Northwestern University and the Niels Bohr Visiting Professor
of Economics at Aarhus University, a research associate of the
National Bureau of Economic Research (NBER), and a research
fellow of the Institute for the Study of Labor (IZA). He and Mr.
Pissarides, 62, applied the idea to the labour market

Prof. Christopher Pissarides,

from London School of Economics

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 Search Theory
• Difficulties buyers and
sellers often face in finding
each other in the
marketplace
• In the job market, where
the buyers and sellers are
employers and workers
• Applied to a host of other
topics, from the housing
market to the search for a
spouse
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 Friction
• High unemployment can
be the result of "friction,“.
• It keeps employers and
workers apart.
• Friction results
– Regulatory rules on firing,
or
– The lack of appropriate
skills among the
unemployed, among other
things.

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 Unemployment Insurance
• More generous benefits
give rise to higher
unemployment,
because workers spend
more time looking.
• It is a benefit to the
economy
• It leads to workers
landing jobs that better
use their capabilities
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 World Unemployment Rate

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 Overview of Employment Theories
• People are without jobs and
they have actively looked for
work within the past four
weeks.
• The unemployment rate is a
measure of the prevalence of
unemployment
• It is calculated as a
percentage by dividing the
number of unemployed
individuals by all individuals
currently in the labour force.

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 Classical Unemployment
• Classical unemployment is
also known as the real wage
unemployment or
disequilibrium
unemployment.
• This type of unemployment
occurs when trade unions
and labor organization
bargain for higher wages,
which leads to fall in the
demand for labor.

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 Cyclical Unemployment
• There is a recession.
• There is a downturn in an
economy
• The aggregate demand for
goods and services decreases
• Demand for labour decreases.
• At the time of recession,
unskilled and surplus labors
become unemployed.
• It is called Keynesian
unemployment

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 Marxist unemployment
According to Karl Marx,
• Unemployment is inherent within the
unstable capitalist system
• Periodic crises of mass expected.
• The function of the proletariat within
the capitalist system is to provide a
"reserve army of labour" that creates
downward pressure on wages.
• This is accomplished by dividing the
proletariat into surplus labour
(employees) and under-employment
(unemployed).
• This reserve army of labour fight
among themselves for scarce jobs at
lower and lower wages.

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 Involuntary Unemployment
• Voluntarily employed are willing
and able to work at any given
wage.
• Some people may be
unemployed simply because
they are looking for a better job
• These people are voluntarily
unemployed.
• Involuntary unemployment does
not exist in agrarian societies nor
is it formally recognized to exist
in underdeveloped.

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 Full Employment
• Full employment is a condition of the
national economy
• All persons willing and able to work at
the prevailing wages and working
conditions are able to do so.
• It is defined either as 0% unemployment,
literally, no unemployment , as by James
Tobin, or
• As the level of employment rates when
there is no cyclical unemployment.
• It is defined by the majority of
mainstream economists as being an
acceptable level of natural
unemployment above 0%, the
discrepancy from 0% being due to non-
cyclical types of unemployment.

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 Full Employment
• The specific level of unemployment that
exists in an economy that does not cause
inflation to increase.
• The non-accelerating rate of
unemployment (NAIRU) often represents
an equilibrium between the state of the
economy and the labour market.
• NAIRU is also sometimes referred as a
"long-run Phillips curve".
– For example, suppose that the
unemployment rate is at 5% and the
inflation rate is 2%.
– Assuming that both of these values remain
the same for a period of years, it can be said
that when unemployment is under 5%, it is
natural for an inflation rate of 2% to
correspond with it.

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 Structural unemployment
• It occurs due to the structural changes
within an economy.
• This occurs when there is a mismatch of
skilled workers in the labour market.
• Some of the causes of the structural
unemployment are
– geographical immobility (difficulty in moving
to a new work location),
– occupational immobility (difficulty in
learning a new skill) and
– technological change (introduction of new
techniques and technologies that need less
labour force).
• Structural unemployment depends on
the growth rate of an economy and also
on the structure of an industry.

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 Frictional unemployment
• Frictional unemployment is a
temporary condition.
• It occurs when an individual is out of
his current job and looking for another
job.
• The time period of shifting between
two jobs is known as frictional
unemployment.
• The probability of getting a job is high
in a developed economy
• This lowers the probability of frictional
unemployment.
• There are employment insurance
programs to tide over frictional
unemployment

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 Beveridge curve
• The frictions in the labour
market are sometimes
illustrated graphically with
a Beveridge curve, a
downward-sloping, convex
curve.
• It shows a correlation
between the
unemployment rate on
one axis and the vacancy
rate on the other.
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 The Beveridge Curve can move for the
following reasons
1. The matching process will determine how efficiently workers find new jobs.
2. Labour force participation rate; as the number looking for jobs increases
relative to total population, the unemployment rate increases, shifting the
curve outwards from the origin.
3. Long-term unemployment will push the curve outward from the origin. This
could be caused by;
• deterioration of human capital or
• a negative perception of the unemployed by the potential employers.
4. Frictional unemployment; a decrease in frictions would reduce the number of
firms searching for employees and the number of unemployed searching for
jobs. This would shift the curve towards the origin. Frictional unemployment is
due
• to job losses,
• resignations and
• job creation.

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 Matching theory
(macroeconomics)- Matching function
• A matching function is a
mathematical relationship
that describes the formation
m a, & b Positive constants. In this equation,
of new relationships from
unmatched agents of the ut the number of unemployed job seekers
in the economy at a given time ,
appropriate types. vt Number of vacant jobs firms trying to
fill.
– For example, in the context of
mt The number of new relationships
job formation, matching (matches) created (per unit of time)
functions are sometimes
assumed to have the
following 'Cobb-Douglas'
form:

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 Matching function
• A matching function is in general
analogous to a production function.
• A production function usually
represents the production of goods
and services from inputs like labour
and capital,
• A matching function represents the
formation of new relationships from
the pools of available unmatched
individuals.
• Estimates of the labor market
matching function suggest that it has
constant returns to scale = a+b
≈1
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 Matching function
• If the fraction of jobs that separate
(due to firing, quits, and so forth)
from one period to the next is d ,
then to calculate the change in
employment from one period to
the next we must add the
formation of new matches and
subtract off the separation of old
matches.
• A period may be treated as a
week, a month, a quarter, or some
other convenient period of time,
depending on the data under
consideration.

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 Matching function
Suppose we write the number of
workers employed in period as
nt = Lt - ut
where Lt is the labor force in period
t. Then given the matching function
described above the dynamics of
employment over time would be
given by

For simplicity, many studies treat d as a fixed constant. But the fraction of
workers separating per period of time can be determined endogenously if
we assume that the value of being matched varies over time for each
worker-firm pair (due, for example, to changes in productivity).

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 Applications
• Matching theory has been
applied in many economic
contexts, including:
– Formation of jobs, from
unemployed workers and
vacancies opened by firms
– Formation of marriages,
from unmatched
individuals
– Allocation of loans from
banks to entrepreneurs
– The role of money in
facilitating sales when
sellers and buyers meet

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 THANK YOU

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 References
References of WIKI endorsed
Pissarides, Christopher (2000), Equilibrium Unemployment Theory, 2nd ed. MIT Press
Economic Prize Committee of the Royal Swedish Academy of Sciences, 'Scientific
Background', page 2.
Barbara Petrongolo and Christopher Pissarides (2001), 'Looking into the black box: a
survey of the matching function'. Journal of Economic Literature 39 (2), pp. 390-431.
Dale Mortensen and Christopher Pissarides (1994), 'Job creation and job destruction in
the theory of unemployment.' Review of Economic Studies 61, pp. 397-415.
Wouter den Haan, Gray Ramey, and Joel Watson (2003), 'Liquidity flows and the
fragility of business enterprises', Journal of Monetary Economics 50 (6), pp. 1215-41.
Nobuhiro Kiyotaki and Randall Wright (1993), 'A search-theoretic approach to
monetary economics'. American Economic Review 83 (1), pp. 63-77.
Robert Shimer (2005), 'The cyclical behavior of equilibrium unemployment and
vacancies'. American Economic Review 95 (1), pp. 25-49.

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