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 underemployment (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. 2. 3. The matching process will determine how efficiently workers find new jobs. 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. 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 of new relationships from unmatched agents of the appropriate types.
± For example, in the context of job formation, matching functions are sometimes assumed to have the following 'Cobb-Douglas' form:
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Qa, & b

Positive constants. In this equation, the number of unemployed job seekers in the economy at a given time , Number of vacant jobs firms trying to fill. The number of new relationships (matches) created (per unit of time)

ut vt mt

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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 H , 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 Has 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. 390431. 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. 121541. 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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