Lecture 2: Frictional unemployment

Lecture 2: Frictional unemployment III. Endogeneizing job destruction

Where are we? • So far, exogenous job destruction rate s • Makes it difficult to talk about institutions such as firing costs • Can’t use the model to explain the cyclical behaviour of job destruction • Can we extend it to make job destruction endogenous?

The Mortensen-Pissarides model • 1 firm = 1 job • Each jobs produces p+σε • ε = idiosyncratic shock • εchanges according to a Poisson process • Arrival rate λ • Drawn from distribution F(), ε < εu • New firms start at ε = εu

The firm’s life cycle: ε εu εd t

The role of turnover costs: • In the absence of turnover costs, free entry at the highest productivity level would drive down all firms such that ε < εu out of the market • Here, profitable to go on rather than repaying the hiring cost next time

Firms:

Workers

Solving the model • The model can be reduced to two conditions • A job creation condition given by • J(εu) = c/q(θ) • A job destruction condition given by • J(εd) = 0

Computing the solution

Graphically: PJD θ PJC εd

Explaining the slopes: • Tighter labor marketsHigher recruiting costsHigher value of a jobLess incentives to destroy jobslower destruction margin • PJC downward sloping • Tighter labor marketsHigher opportunity cost of not searching Lower surplusHigher destruction margin • PJD upward sloping

Comparative statics

Lecture 2: Frictional unemployment