Monday, October 11, 2010

2010 Nobel prize in economics

Peter Diamond, Dale Mortensen and Christopher Pissarides share 2010 Nobel prize in economics for “their analysis of markets with search frictions”.

Why are so many people unemployed at the same time that there are a large number of job openings? How can economic policy affect unemployment? This year's Laureates have developed a theory which can be used to answer these questions. This theory is also applicable to markets other than the labor market.

On many markets, buyers and sellers do not always make contact with one another immediately. This concerns, for example, employers who are looking for employees and workers who are trying to find jobs. Since the search process requires time and resources, it creates frictions in the market. On such search markets, the demands of some buyers will not be met, while some sellers cannot sell as much as they would wish. Simultaneously, there are both job vacancies and unemployment on the labor market.

This year's three Laureates have formulated a theoretical framework for search markets. Peter Diamond has analyzed the foundations of search markets. Dale Mortensen and Christopher Pissarides have expanded the theory and have applied it to the labor market. The Laureates' models help us understand the ways in which unemployment, job vacancies, and wages are affected by regulation and economic policy. This may refer to benefit levels in unemployment insurance or rules in regard to hiring and firing. One conclusion is that more generous unemployment benefits give rise to higher unemployment and longer search times.

Search theory has been applied to many other areas in addition to the labor market. This includes, in particular, the housing market. The number of homes for sale varies over time, as does the time it takes for a house to find a buyer and the parties to agree on the price. Search theory has also been used to study questions related to monetary theory, public economics, financial economics, regional economics, and family economics.


  1. Thanks for a nice summary, Chandan.

    (I am a professional economist as well, although a bit out of touch now. I work inside government, not in the academia.) Unfortunately, I can't (at the moment) figure out what these economists are saying.

    Re: "more generous unemployment benefits give rise to higher unemployment and longer search times."

    a) Are they saying that there are transaction costs in the labour market? That is such ancient knowledge. What's new?

    b) Are they trying to suggest that governments can do better than markets? I read elsewhere in a summary that they are saying that "governments need to cut benefits and tackle restrictive practices and regulations in the labour market to boost employment levels." ( If what they are saying is that the government should get OUT of labour market regulation, I'm with them. But I hope they aren't saying that governments can do better than the markets... Governments are FLOODED WITH CONFUSED DO-GOODERS who create more harm than good! I hope they know that.

    Your detailed views on the implications of these economists' findings would be appreciated.


  2. Thanks for the stimulating comment, Sanjeev. Based on the readings of their work so far, let me address your questions.

    a) I think transaction costs are included in search costs. This seems intuitive, but they modeled this fact and showed that classical market clearing assertion does not hold. This is great by itself. Even the concept of transaction costs seemed intuitive in the beginning. But, it was not until Ronald Coase put it in model and its explained existence that economists started researching on it.

    b) I don’t think they are saying government can necessarily do better than markets, or vice versa. Reading their stuff, I think they are saying that unlike in the unregulated classical models, when search costs exist, there could be several optimal points, but only one superior optimal point. This is where the role of the government comes in. It can find ways to ensure that the search process results in a superior outcome when the final deal is sealed. Unutilized resources can be put to good use by intervention from an external agent. The search and matching environment can lead to macroeconomic unemployment problems as coordinating trade does not match one-to-one. This provides a rationale for “aggregate demand management” to steer the economy towards the best equilibrium. Diamond’s work is viewed as “a careful analysis, using microeconomic foundations, to analyze some of the central themes of Keynes’s business-cycle theory.” Coordination problems feature on both of their writings. An appropriate intervention by the government can address coordination problems.

    More here: