Unemployment, Vacancies, Wages

1045 We have all visited several stores to check prices and/or to find the right item or the right size. Similarly, it can take time and effort for a worker to find a suitable job with suitable pay, and for employers to receive and evaluate applications for job openings. Search theory explores the workings of markets once facts such as these are incorporated into the analysis. Adequate analysis of market frictions needs to consider how reactions to frictions change the overall economic environment: not only do frictions change incentives for buyers and sellers, but the responses to the changed incentives also alter the economic environment for all the participants in the market. Because of these feedback effects, seemingly small frictions can have large effects on outcomes. Equilibrium search theory is the development of basic models to permit analysis of economic outcomes when specific frictions are incorporated into simpler market models. The primary friction addressed by search theory is the need to spend time and effort to learn about opportunities—opportunities to buy or to sell, to hire or to be hired. There are many aspects of a job and of a worker that matter when deciding whether a particular match is worthwhile. Such frictions are naturally analyzed in models that consider a process over time—of workers seeking jobs, firms seeking employees, borrowers seeking lenders, and shoppers buying items that are not part of frequent shopping. Search theory models have altered the way we think about markets, how we interpret market data, and how we think about government policies. The complexity of the economy calls for the use of multiple models that address different aspects of the determinants of unemployment (and other) outcomes. This view was captured so well by Alfred Marshall (1890: 1948 edition, p. 366) that I have quoted this passage repeatedly since coming upon it while doing research for the Churchill Lectures (Diamond 1994b).