News & Views item - October 2010

 

 

 The Economic Prize in Memory of Alfred Nobel 2010 Awarded to Peter Diamond, Dale Mortensen and Christopher Pissarides For Analysis of Markets With Search Frictions. (October 12, 2010)

In economic terminology if the matching of job vacancies were able to be filled virtually immediately with available employees perfectly suited to requirements the system would be deemed economically frictionless; in general terms supply and demand would be able to be perfectly matched. In reality this is not the case and in fact can never be, there will always be significant time lags, i.e. there exist "search frictions".

 

 

The work by Peter Diamond, Massachusetts Institute of Technology; Dale Mortensen, Northwestern University and Christopher Pissarides, London School of Economics has been most influential in the study of labour markets, where the so-called Diamond-Mortensen-Pissarides (DMP) model has become the most widely-used analytical tool.

 

Following is a short summary of material supplied by the Economic Sciences Prize Committee of the Royal Swedish Academy of Sciences

 

A steady state of supply and demand entails "equilibrium" in the labour market in the sense that the unemployment rate is unchanging over time. This occurs when the inflow from employment into unemployment equals the outflow from unemployment to employment. The steady-state unemployment to employment implies a negative relationship between unemployment and vacancies known as the Beveridge curve, after the British economist William Beveridge (1879-1963).

 

 

A decline in job finding given a certain level of tightness, involves an outward shift of the Beveridge curve. An increase in the job destruction rate, possibly induced by faster sectoral reallocation of jobs, is also associated with an outward shift of the Beveridge curve. On the other hand, since other model parameters, such as the productivity of a match between worker and employer (due to technology or aggregate-demand factors), do not appear in this relation, movements in these parameters imply movements along the curve. These differences between model parameters allow us to gain insights into which fundamental factors are the likely determinants of unemployment and job vacancies.

 

 

U.S. monthly data on unemployment and vacancies since 2000 are depicted in Figure 2.The movements indicate a strong negative relationship, with little evidence of strong shifts for most of the period, thus suggesting that movements in productivity/demand account for most of the aggregate fluctuations in the labour market. During the current crisis, a marked outward shift has been observed. The reasons for this shift are not yet well understood.

 

The Economics Prize Committee concluded its evaluation:

 

Search and matching theory has evolved from microeconomic decision theory to the leading paradigm in macroeconomic analyses of the labour market. The theory has also proven to be eminently fruitful in many other areas. It has shed light on a host of policy issues and has initiated a vast empirical literature. The three leading contributors to search and matching theory are Peter Diamond, Dale Mortensen, and Christopher Pissarides. Diamond, Mortensen, and Pissarides have developed search and matching theory in a number of important ways. These include (i) the literature on wage and price dispersion in search equilibrium; (ii) the literature on macroeconomic coordination problems; (iii) foundational work on constrained efficiency in search and matching markets; and (iv) and the development of the canonical Diamond-Mortensen-Pissarides model of unemployment, which has become a workhorse in macroeconomic analysis and is an important tool for policymaking.