Monday, October 11, 2010

The Economics Nobel

The 2010 Nobel Memorial Prize in Economic Science (not a real Nobel! - there are you haters satisfied) went to three economists for their work in labor markets and their frictions.

I have actually referenced this work recently (unbeknownst to my readers) in my post on tip credits.  Many bloggers and reporters are explaining the work and what it means and each person will have their own unique take on it, so here I will give you mine.

Standard textbook models of labor markets assume no frictions and complete information.  Everyone knows everything about everything and therefore hiring the right person for the job is a snap.  In fact 101 level models have a labor supply curve and a labor demand curve and thus assume homogeneous workers and jobs.  This might be (and probably is) a good starting point but of course the real world is a lot different.  People possess unique skills and qualities and jobs require unique skills and qualities but finding the right match in a job search process on either the worker or the employer side is a challenge. This can lead to delays in filling jobs and in finding jobs.  We had understood such frictions in principle for eons and thus would talk of 'natural rates of unemployment' without really understanding the process or the implications.

The theoretical challenges were hard, you had to work in a dynamic environment with heterogenous agents and probabilities of matches.  Thankfully methods from macroeconomics provided a starting point, but there was a lot of heavy lifting to be done.  Now we have a much better understanding of the type of frictions that exist in job markets and what happens in things like recessions.

It is also a framework through which we can assess things like the effect of minimum wages on employment (which is where my reference to the work entered in my tip credit post).  101 level textbooks just model a wage floor and resulting unemployment - but search models suggest that things like if minimum wages increases the tenure of workers, this can cut down on costly search activities in markets and leave us better off.

It is no accident that they were awarded the Nobel this year when unemployment is on the top of everyone's mind, but this is Nobel quality work regardless.


NB: Here is Ed Glaeser's write-up - the best I have seen so far.


Lestatdelc said...

It is also worth noting that President Obama nominated Mr. Diamond (one of the three Nobel winners) to the board of governors of the Federal Reserve, where his former student, Mr. Bernanke, has been chairman since 2006.

But under an arcane procedural rule, the Senate sent Mr. Diamond’s nomination back to the White House on Thursday night before starting its summer recess. A leading Republican senator, Richard Shelby of Alabama, said that Mr. Diamond did not have sufficiently broad macroeconomic experience to help run the central bank.

Dann Cutter said...

In reading the frictive model explanations, is this applicable to information transfer as well? i.e. Market friction exists between the public awareness of information and rational actors finding and making decisions based on it?

Patrick Emerson said...

Yes, these are actually more general 'search' models. The application to labor markets are what the Nobel is honoring this year, but in general these models are incredibly useful in understanding lots of areas in which information is not full (as is necessary for our standard market models).

For example applied to internet retail, one might expect that the cost of search is so reduced, prices will be pushed down to MC. But this also allows easy monitoring on the part of competitors and can therefore facilitate collusion.