An Introduction to the Search Theory of Unemployment

On any given day, during economic busts and economic booms alike, millions of Americans are unable to find desirable employment despite their best efforts. Understanding the reasons for this fact is a chief concern for economists and policymakers, since it is necessary for designing good labor market policies. Unemployment not only creates hardships for those it encompasses, but it also seems to represent a vast pool of idle economic resources. Classical labor theory is not well suited to thinking about unemployment, for within this framework the amount of labor that workers supply is exactly equal to the amount of labor demanded by firms at the equilibrium wage— therefore, there is no unemployment. This feature of classical theory has contributed to the historical interpretation of unemployment, or at least a portion of unemployment, as a disequilibrium or an involuntary phenomena. While such terminology has permeated discussions of unemployment, it has done little to enhance our understanding of the underlying determinants of unemployment or its behavior through time and across countries.1 A different approach to the study of unemployment, which sought to directly explain the frequency and duration of unemployment spells, took root during the 1970s. The building block of this approach is the simple observation that finding a good job (or a good worker, in the case of a firm) is an uncertain process which requires both time and financial resources. This assumption stands in contrast to the classical model, in which workers and firms are assumed to have full information at no cost about job opportunities and workers. The alternative approach, referred to as the search theory of unemployment, seeks to understand unemployment in the context of a model in which the optimizing behavior of workers and firms gives rise to an equilibrium rate of unemployment. Furthermore, it has the potential to explain the striking fact that while millions of workers are unemployed, firms are simultaneously looking to fill millions of jobs.