Corporate & Securities Law

Nobel Prize for Unemployment Theory

Congratulations to Peter A. Diamond, Dale T. Mortensen, Christopher A. Pissarides for taking home the 2010 Nobel Prize.  As Alex Tabarrok notes, this year’s prize can usefully be thought of as a prize for unemployment theory.  See also Tyler Cowen’s profiles of Diamond, Mortensen, and Pissarides.  I think the most useful short summary of this year’s prize is from Ed Glaeser (HT: Steve Salop).    Glaeser writes about the new Laureates contribution to understanding frictions in the labor market:

The most traditional economic model of the labor market assumes a labor supply schedule, which reflects the number of workers willing to work at a given wage, and a labor demand schedule, which describes the number of workers that companies are willing to hire at a given wage. At some wage, supply equals demand and that?s the market equilibrium, which is where traditional economics predicts the world will end up. In markets with undifferentiated products ? like copper or winter wheat ? that model works pretty well, but it has some pretty obvious failings when it comes to labor or housing markets.

In particular, the Economics 101 model does an awful job explaining an American civilian labor force where nearly one-tenth say they want a job and can?t find one. Die-hard supporters of the basic model sometimes argue that wage floors, like the minimum wage, keep wages too high for the market to clear. But American minimum wages are low, and only a small fraction of jobs are affected by that barrier. Another attempt to save the old model is to argue that unemployed workers just value their time too highly to take a job at current market rates. But the view that the unemployed are just having a swell time hanging out watching cable is wildly at odds with the real world. New paradigms emerge when reality crashes against theory, and that?s what brought us the search theory of Professors Diamond, Mortensen and Pissarides.

More from Steve Levitt here.

Full post as published by Truth on the Market on October 11, 2010 (boomark / email).