Decentralized Trade, Entrepreneurial Investment and the Theory of Unemployment

This paper considers an equilibrium model of unemployment in a labour market where all vacancies are advertised in a newspaper. Unemployment occurs in occupations that are short on vacancies. New vacancies are created by entrepreneurial search and investment, so it may take some time before an unemployed worker finds a job. Wages are determined by bargaining. A unique rational expectations equilibrium is shown to exist. The unemployment-vacancy dynamics are consistent with so-called Beveridge curves. Individual unemployment spells can be long – especially in low turnover markets – while markets with high turnover experience large variations in unemployment and little wage variation. Although this latter case appears to exhibit ‘sticky wages’, this market outcome is (asymptotically) fully efficient. Although the appropriate government policy is to subsidize entrepreneurial investment (there is a wage bargaining distortion and a search externality), simulations show that the required subisidies are very small for appropriate parameter values. A laissez-faire policy is (almost) optimal even with unemployment spells as long as a year in some markets.