Search theories - a brief'' historical overview, Managerial Economics


A search theory of unemployment is found even in the writings of A. C. Pigou in  the inter-war  period. To explain the  high unemployment prevalent  at  that time Pigou  used  an idea  you  are very familiar with  - that workers are unemployed  because wages are too  high. Keynes contested  this idea in  the development of his General  Theory of Employment,  Interest  and Money.  But initially Pigou  had tried  to explain the  high unemployment  of  the inter-war period with  reference to another  idea  -  the  idea of  frictional unemployment, where  unemployment arises  as  workers  shift  between jobs, moving  to jobs where  their productivity  is  higher.  Search  and  matching  unemployment is actually a  form of frictional  unemployment  - unemployment which  arises because of the frictions in shifting between  jobs generated by  the fact that skills are to be matched with vacancies in the job  'market'. Pigou himself was aware  though that jobs  were not  shifting around  too much  in  the  1920s, so  that he ultimately  banked more  on  'workers  pricing themselves out  of  the  market through trade  union  activities'  as  an  explanation  for  the  inter-war unemployment. 

The  idea of  search unemployment was subsequently formalised  in  the 1970s and  1980s  to make the neoclassical Walrasian model accord with the reality of the empirically observed and  varying unemployment  in the labour market, as has been  indicated to you in the introductory section. The importance of search in decentralised markets was first emphasized  in an  influential book edited by Edmund  Phelps  in  1970  (Microeconomic Foundations of  Employment  and Inflation  Theory, Norton,  New York).  This book  contains some of the first formal models using search theory to explain unemployment as an  equilibrium phenomenon. Lucas and Prescott presented in 1974 a general equilibrium model of  unemployment.  In  this model  stochastic sectoral shocks induce workers  to move  between  sectors,  but  there  is  a  one-period lag  by  workers in moving between  sectors, brought  about  through search  and  matching  kind  of considerations. Unemployment is generated in the model by this lag. 

In  the  1980s,  search models were  built  up  as .continuous  time general equilibrium models, in the tradition of the models built under the real business cycle theory. Noteworthy amongst these are the models by Peter Diamond: the paper  titled  "Mobility  Costs, Frictional  Unemployment, and Efficiency" published in the Journal of  Political  Economy  in  1981, and  by  Christopher Pissarides: the  paper  titled  "Short-Run  Equilibrium  Dynamics  of Unemployment,  Vacancies,  and  Real  Wages"  published  in  the  American Economic Review  in  1985. We have reproduced the titles of the papers for you because  they  provide a flavour of  the  concepts  and  mechanisms  used  to rationalize unepployment as an equilibrium phenomenon in a Walrasian model.

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