Do I have what it takes? Equilibrium Search With Uncertainty About the Self

This paper develops a search model of the labor market in which uncertainty about job finding probabilities leads unemployed to become discouraged and exit the labor market. Negative updating after unsuccessful search implies that the beliefs of the unemployed about themselves, and consequently their subjective job finding probabilities, decline with unemployment duration. The assumptions about uncertainty and updating are motivated by experimental behavioral evidence. The resulting negative duration dependence in subjective job finding probabilities also affects starting wages through workers’ threat points. Discouragement generates structural flows from unemployment to nonparticipation as a consequence of rational choices rather than stochastic shocks. Unemployment, labor market tightness, job offer arrival rates, and wages are determined endogenously in equilibrium. The implications provide a novel interpretation of recent empirical evidence.