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Journal ArticleDOI

Search-Theoretic Models of the Labor Market: A Survey

01 Nov 2005-Journal of Economic Literature (American Economic Association)-Vol. 43, Iss: 4, pp 959-988

Abstract: We survey the literature on search-theoretic models of the labor market. We show how this approach addresses many issues, including the following: Why do workers sometimes choose to remain unemployed? What determines the lengths of employment and unemployment spells? How can there simultaneously exist unemployed workers and unfilled vacancies? What determines aggregate unemployment and vacancies? How can homogeneous workers earn different wages? What are the tradeoffs firms face from different wages? How do wages and turnover interact? What determines efficient turnover? We discuss various modeling choices concerning wage determination and the meeting process, including recent models of directed search.
Topics: Unemployment (58%), Wage (54%)

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NBER WORKING PAPER SERIES
SEARCH-THEORETIC MODELS OF THE LABOR MARKET:
A SURVEY
Richard Rogerson
Robert Shimer
Randall Wright
Working Paper 10655
http://www.nber.org/papers/w10655
NATIONAL BUREAU OF ECONOMIC RESEARCH
1050 Massachusetts Avenue
Cambridge, MA 02138
August 2004
The views expressed herein are those of the author(s) and not necessarily those of the National Bureau of
Economic Research.
©2004 by Richard Rogerson, Robert Shimer, and Randall Wright. All rights reserved. Short sections of text,
not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including
© notice, is given to the source.

Search-Theoretic Models of the Labor Market: A Survey
Richard Rogerson, Robert Shimer, and Randall Wright
NBER Working Paper No. 10655
August 2004
JEL No. E2, J6
ABSTRACT
We survey search-theoretic models of the labor market and discuss their usefulness for analyzing
labor market dynamics, job turnover, and wages. We first examine single-agent models, showing
how they can incorporate many interesting features and generate rich predictions. We then consider
equilibrium models that endogenize several variables that are treated parametrically in single-agent
models, including the arrival rate of job offers and the wage distribution. We survey alternative
formulations of these models, emphasizing two key issues: how workers and firms meet, and how
wages are determined. We emphasize throughout the implications of alternative assumptions for
turnover, wage dispersion, and efficiency.
Richard Rogerson
Departement of Economics
WP Carey School of Business
Arizona State University
Tempe, AZ 85287
and NBER
richard.rogerson@asu.edu
Robert Shimer
Department of Economics
University of Chicago
1126 East 59
th
Street
Chicago, IL 60637
and NBER
shimer@uchicago.edu
Randall Wright
Department of Economics
University of Pennsylvania
3718 Locust Walk
Philadelphia, PA 19104
and NBER
rwright@econ.sas.upenn.edu

Searc h-Theoretic M odels of the Labor
M arket: A Surv ey
Ric hard Rogerson Robert Shimer Randall Wrigh t
July 9, 2004
1 Introduction
The economic fortunes of most individuals are largely determined by their la-
bor market experiences. Hence, economists are natura lly interested not only
in documenting and analyzing the empirical behav ior of w ages and employ-
ment, but also in building models within which we can study labor marke t
outcomes fr om both a positiv e and a no rmativ e perspectiv e , a nd within which
we can assess the consequences of cha nges in labor market policies, regula-
tions and institutions. Wh ile the usual paradigm of supply and demand
in a frictionless labor m a rk e t is use ful for discussin g some of the questi o ns,
importan t phenomen a not easily addressed in this setup include labor mar-
k et transitions, such as movemen ts between employment and unemployment,
and the distribution of w ages across individuals and o ver time.
Since its inception searc h theory has been extremely useful for thinking
about these things, and for addressing a host of related empirical and policy
issues. Even th e earliest models that study a single agent in isolation enhance
our understanding and our abilit y to organize observations about the work
histories o f individuals. But more recently, equilibrium search theory has
embedded these agents into models that endogenously determine importan t
Rogerson: Arizona State University. Shimer: University of Chicago. Wright: Univer-
sit y of Pennsylvania. We would lik e to thank Daron Acemoglu, Ken Burdett, Gwen Eudey,
Derek Laing, John McMillan, Dale Mortensen and Peter Rupert for their input. We also
thank the Federal Reserve Bank of Cleveland, ERMES at Paris 2, the National Science
Foundation, and the Sloan Foundation for research support.
1

variables like job creation and destruction rates and the wa ge distribution.
The goal of this surv ey is to summarize these eorts, and in the process
to pro vide a unifying perspectiv e within whic h the various models can be
seen. Throug hou t the presentation we will emphasize three things that search
theory helps us understand: job creation, job destruction, and w ages.
The kinds of questions that we will be concerned with include the fol-
lo w ing. Wh at economic factors determine labor mark et transitions, and in
particular what determines the equilibrium unemp loyment rate? W hy do
unem ploy e d agents sometimes c hoose to remain unemp loy ed , say b y turn-
ing down oers, and more generally what determines the length of unem-
ployment spells? How can ostensibly homog en eous workers end up with
dierent w ag es? What are the trade-os faced b y rms when they pa y dif-
feren t w ages? What are the interactions between w ages and turnov er? And
what determines the ecient amount of turno ver? This essa y sho ws that
searc h theory pro vides a rigorous y et tractable framew ork that can be used
to address these questions, and thereby provides important insights into the
functioning of modern labor mark ets.
At the outset, it is importan t to point out that searc h theory constitutes
a v ery large branch of economics. In addition to labor it has been used in
many applications in both micro and macro, including m oneta ry theory, in-
dustrial organization, nan ce, and the econo m ics of the ma rriage market, all
of whic h w e must neglect lest this surv ey becomes unmanagea ble.
1
Searc h
has been used in tec hnical theoretical w ork, and has been a workhorse for
empirical economics, but w e can neither delve in to pure theory nor pay ap-
propriate atten t ion to all of the econometric issues or empirical results here.
2
Also, while the analysis will strive to be rigorous, w e wa nt to emphasize
application s and issues– th at is, what can we learn about labor economics
from these m odels–and not models or methods per se. Hence the presenta-
tion will revolve around the w ays in which the models help us think about
1
Examples in monetary economics include Kiyotaki-Wright (1993), Shi (1995) and
Trejos-Wright (1995); examples in the marriage literature include Mortensen (1988),
Burdett-Coles (1997, 1999) and Shimer-Smith (2000); examples in IO include Salop (1977),
Jovanovic (1982), Jovanovic-MacDonald (1994), and Jovanovic-Rob (1989); examples in
nance include Due-Garleanu-Pedersen (2002) and Weill (2003).
2
Examples of theoretical work studying the question of whether frictionless competitive
equilibrium can be considered the limit of search equilibrium as the frictions get small
include Rubinstein-Wolinsky (1987), Gale (1987) and Mortensen-Wright (2002). Devine-
Kiefer (1991) and Wolpin (1995) provide surveys of empirical applications.
2

substantiv e issues related to turnove r and wages.
The essay proceeds as follo ws. In Sections 2 and 3 we study the problem
of a single agent, not only because this is the w ay the literature began but
because it is an important com ponent of the equilibrium models that follow.
In Section 4 w e consider models that build upon two main ingredients: the
matc hing function, which determines ho w w orkers and rm s get together, and
the bargaining solution, which determines the wage once they do. In Section
5 we study a class of models where w a ges are posted ex ante, rather than
bargained after w orkers and rms meet, and where agen ts use directed rather
than random search. In Section 6 we discuss models with nontransferable
utility, where the focus is on determining which matches get consumm a ted.
In Section 7 w e presen t models w here w ages are posted ex an te but search is
once again random, with an emphasis on wage dispersion. In Section 8 w e
discusses eciency.
Although the dierent version s of the model that we present sometim es
adopt some ver y dierent assumptions–e.g. random versus directed searc h,
transferrab le versus non tr an sferab le utility, bargaining versus wage posting,
and so on–we wan t to emphasize that they are really dierent applications
of the same framework, and in eac h case the analysis uses the same set of
basic tools. Our goal is that, with a little work, the reader should feel at
theendofthisarticlethatsearchtheoryisaexible and broadly applicable
paradigm for organizing our thinking about labor markets, and that this will
stim u late even more learning and researc h in the area.
3
2 A Simple Model
We begin with the problem of an individual searching for a job in real tim e,
taking market conditions as giv en.
4
He seeks to maxim ize E
P
t=0
β
t
x
t
,where
3
Earlier surveys include Lippman-McCall (1976a), Mortensen (1986) and Mortensen-
Pissarides (1999a,b). Naturally there is some overlap with the current essay, although our
approac h and many of the issues we address are dierent. Examples of things emphsized
here and not in those papers include the directed search models in Section 5, the non-
transferable utility models in Section 6, some of the wage dispersion models in Section 7,
and aspects of our approach to eciency in Section 8.
4
While it is often said that the economics of search began with Stigler (1961), his
formulation w as not really dynamic. McCall (1970), Mortensen (1970) and Gronau (1971)
presented the rst sequential models of job search, although others had posed related
problems (including Simon 1955, who discussed looking for a house).
3

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