Tuesday, October 12, 2010

Nobel prize in economics

This year the Swedish Royal Academy of Sciences awarded the Nobel Memorial Prize in Economics to three economists who have done path-breaking research on how markets adjust when buyers and sellers have to search: Peter Diamond of MIT, Dale Mortensen of Northwestern, and Chris Pissarides of the London School of Economics.  Click for WSJ and NYT news accounts. 

The labor market has been the main area of application of their work.  In simple markets, when there is excess supply or excess demand, the price adjusts and supply once again equals demand -- end of story.  The labor market is different because employers and applicants have to (1) find each other and (2) jointly determine whether they are a good match for each other at a given salary.  Because employers and applicants need time to search and screen, there always will simultaneously be unemployed workers and open positions.  The same type of analysis also applies to housing markets and mating markets. 

Their framework has been used to show how unemployment benefits reduce search intensity and limit the range of acceptable job offers, thereby raising unemployment.  Another insight: European countries limit the ability of firms to fire or layoff workers, so knowing this the companies become less likely to offer positions and unemployment rises. 

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