Equilibrium Search with Time-Varying Unemployment Benefits∗

In this paper we show how time-varying unemployment benefits can generate equilibrium wage dispersion in an economy in which identical firms post wages and homogeneous risk-averse workers search for acceptable offers. We model a two-tier unemployment benefit system that is similar to real-world unemployment insurance programs. We assume that the unemployed initially receive benefits at rate b. Eventually, if a worker does not in the meantime find and accept a wage offer, the benefit falls to a lower level, s. The duration of high-benefit receipt is treated as an exponential random variable, so the model is stationary. We characterize the equilibrium, and we derive the comparative statics effects of changes in the unemployment compensation system (i.e., in the two benefit levels and in the expected duration of the high-benefit state) on the equilibrium wage distribution and the unemployment rate.