Search frictions and job search
In the textbook supply-and-demand model wages adjust until the market clears, which makes it hard to explain why job seekers and vacancies exist side by side. George Stigler (1961) brought the cost of gathering price information into economics, and John McCall (1970) modeled job search as an optimal stopping problem: a worker receives wage offers one at a time, accepts any offer above a reservation wage and keeps searching otherwise. The prediction that more generous unemployment benefits raise the reservation wage and lengthen search became a benchmark for research on unemployment insurance. From this angle some unemployment is not a market failure but the natural by-product of looking for better matches, providing micro foundations for the natural rate of unemployment.
The DMP model and the matching function
Peter Diamond (1982), Dale Mortensen (1982) and Christopher Pissarides (1985) extended individual search to market equilibrium. Their central device, the matching function, maps the number of unemployed workers and vacancies into the number of hires per period and is usually estimated as a Cobb-Douglas function with constant returns (Petrongolo and Pissarides, 2001). The higher labor-market tightness, the ratio of vacancies to unemployment, the faster workers find jobs and the harder firms find workers. Once a match forms, the surplus is split by Nash bargaining to set the wage, and firms post vacancies until expected profit equals posting cost. Mortensen and Pissarides (1994) added endogenous job destruction, explaining why destruction spikes in recessions. The Beveridge curve, the inverse relationship between unemployment and vacancy rates, is the standard way to confront the model with data. The three shared the 2010 Nobel Prize.
Efficiency, puzzles and extensions
In search markets each searcher changes everyone else's matching odds, creating congestion externalities. Arthur Hosios (1990) showed that equilibrium is efficient only when workers' bargaining share equals the elasticity of the matching function with respect to unemployment, the Hosios condition. Robert Shimer (2005) pointed out that the standard model cannot reproduce the large cyclical swings in unemployment and vacancies, the Shimer puzzle, and Robert Hall (2005) addressed it with wage rigidity. Search theory has spread to marriage, housing and financial markets (Rogerson, Shimer and Wright, 2005), and together with Gale and Shapley's (1962) stable matching theory, which pairs agents by preference rankings without prices, it underpins how economists think about hiring platforms and assignment systems.
FAQ
- What is search and matching theory in simple terms?
- It says unemployment persists even when jobs are available because workers and employers need time and effort to find each other.
- What is the Beveridge curve?
- It plots the inverse relationship between the unemployment rate and the job vacancy rate; an outward shift is read as a decline in matching efficiency.
Sources reviewed: 2026-10-26
References
- Stigler, G. J. (1961). The economics of information. Journal of Political Economy, 69(3), 213–225.
- McCall, J. J. (1970). Economics of information and job search. Quarterly Journal of Economics, 84(1), 113–126.
- Diamond, P. A. (1982). Aggregate demand management in search equilibrium. Journal of Political Economy, 90(5), 881–894.
- Mortensen, D. T. (1982). Property rights and efficiency in mating, racing, and related games. American Economic Review, 72(5), 968–979.
- Pissarides, C. A. (1985). Short-run equilibrium dynamics of unemployment, vacancies, and real wages. American Economic Review, 75(4), 676–690.
- Mortensen, D. T., & Pissarides, C. A. (1994). Job creation and job destruction in the theory of unemployment. Review of Economic Studies, 61(3), 397–415.
- Pissarides, C. A. (2000). Equilibrium Unemployment Theory (2nd ed.). Cambridge, MA: MIT Press.
- Hosios, A. J. (1990). On the efficiency of matching and related models of search and unemployment. Review of Economic Studies, 57(2), 279–298.
- Petrongolo, B., & Pissarides, C. A. (2001). Looking into the black box: A survey of the matching function. Journal of Economic Literature, 39(2), 390–431.
- Shimer, R. (2005). The cyclical behavior of equilibrium unemployment and vacancies. American Economic Review, 95(1), 25–49.
- Hall, R. E. (2005). Employment fluctuations with equilibrium wage stickiness. American Economic Review, 95(1), 50–65.
- Rogerson, R., Shimer, R., & Wright, R. (2005). Search-theoretic models of the labor market: A survey. Journal of Economic Literature, 43(4), 959–988.
- Gale, D., & Shapley, L. S. (1962). College admissions and the stability of marriage. American Mathematical Monthly, 69(1), 9–15.