Olivier Blanchard

February 1998

This third model takes as its starting point that the labor market is a decentralized market, with large flows in and out of jobs, and decentralized wage bargain-ing. The purpose is to characterize the equilibrium level of unemployment and itsdeterminants. Pfhe model will serve as a building block for many extensions later.The presentation of the model is a bit different from the usual one. This is actually to make the model look more like those we have seen before, with a wage equation/labor supply relation, and short- and long-run demand relations, determining the equilibrium. But the model is a close cousin to -and builds on-those developed over time by Diamond (1982), Pissarides (1990), and Pissarides and Mortensen (1997), among others.

The general picture(1) Job creation and destruction Jobs are continually created and destroyed. New jobs are productive; if paired with a worker, they produce y. Thus, new jobs look for workers. Jobs become unproductive with instantaneous probability s, and are then closed. Workers in

jobs that become unproductive look for new jobs.