Search Theory and Unemployment 

You must understand the search and matching theories of unemployment in  the context of other theories of unemployment. With this objective  in  view, we classify, in  this section, the theories of unemployment that we are studying into four kinds. If  there is unemployment  in  a Walrasian labour market, unemployed workers would immediately bid  down wages until supply and demand for labour are again  in  balance.  If  this process of bidding down wages  is not working freely, there must be distinct reasons for it. We classify the theories of unemployment according  to whether the process of wage  adjustment  is working  or  not,  and according to the reason why  it is not working in cases where it does not work. In  particular, consider an unemployed worker, who claims  to be  identical to a firm's  current workers,  and who offers  to work  for the firm at a marginally lower wage  than  the one the firm is currently paying to  its workers. There are four possible responses of the firm, giving us four kinds of theories  of unemployment. These responses are: 

i)  If  the firm accepts the worker's offer, we  can conclude that the market for labour is Walrasian.  In  this view  all  observed unemployment  is voluntary unemployment  - unemployment  of  people moving between  jobs  and  of those who are ready  to work only at wages higher than the prevalent wage rate.  This  is  really the  neoclassical model  of unemployment referred to above. 

ii)  Secondly, the firm can respond to the unemployed worker's offer by  saying that  it does not accept the premise that the unemployed worker  is identical to  the firm's current  employees.  In  this  view, the labour market is  not  a market for a homogenous commodity, but  is characterised by heterogeneity. Each job is unique  and  requires the unique skills that are embodied  in  an individual. The  unemployed  workers are matched with existing vacancies not through the market, but through a complex process of search and match. The models of unemployment that postulate such a process are called search and matching models.  

iii) Thirdly, the  firm can respond  by  saying that, even though it would  like to cut the wages and employ the additional worker, it cannot do this because it is bound  by  implicit and  explicit  agreements with  its workers, arrived  at through collective  bargaining, regarding the wages  that  have  to  be  paid. Wages  are thus institutionally  determined  in these  models  know  as contracting models. 

iv) Lastly, the firm may respond by saying that  it does not want to,reduce real wages -  it believes that the benefits  accruing to it  from higher wages  are more than the costs of maintaining wages high.  Theories that build  up on this  idea are called eflciency-wage  theories in an obvious reference  to the fact that higher wages impart benefits to  the employing firm by  improving the efficiency of labour.