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312UNEMPLOYMENT,VACANCIES,WAGES1PrizeLecture,December8,2010byPETERA.DIAMONDMassachusettsInstituteofTechnology(MIT),Cambridge,MA,U.S.A.Wehaveallvisitedseveralstorestocheckpricesand/ortofindtherightitemortherightsize.Similarly,itcantaketimeandeffortforaworkertofindasuitablejobwithsuitablepayandforemployerstoreceiveandevaluateapplicationsforjobopenings.Searchtheoryexplorestheworkingsofmarketsoncefactssuchastheseareincorporatedintotheanalysis.Adequateanalysisofmarketfrictionsneedstoconsiderhowreactionstofrictionschangetheoveralleconomicenvironment:notonlydofrictionschangeincentivesforbuyersandsellers,buttheresponsestothechangedincentivesalsoaltertheeconomicenvironmentforalltheparticipantsinthemarket.Becauseofthesefeedbackeffects,seeminglysmallfrictionscanhavelargeeffectsonoutcomes.Equilibriumsearchtheoryisthedevelopmentofbasicmodelstopermitanalysisofeconomicoutcomeswhenspecificfrictionsareincorporatedintosimplermarketmodels.Theprimaryfrictionaddressedbysearchtheoryistheneedtospendtimeandefforttolearnaboutopportunities–opportunitiestobuyortosell,tohireortobehired.Therearemanyaspectsofajobandofaworkerthatmatterwhendecidingwhetheraparticularmatchisworth-while.Suchfrictionsarenaturallyanalyzedinmodelsthatconsideraprocessovertime–ofworkersseekingjobs,firmsseekingemployees,borrowersseekinglenders,andshoppersbuyingitemsthatarenotpartoffrequentshopping.Searchtheorymodelshavealteredthewaywethinkaboutmarkets,howweinterpretmarketdataandhowwethinkaboutgovernmentpolicies.Thecomplexityoftheeconomycallsfortheuseofmultiplemodelsthataddressdifferentaspectsofthedeterminantsofunemployment(andother)outcomes.ThisviewwascapturedsowellbyAlfredMarshall(1920:1948edition,page366)thatIhavequotedthispassagerepeatedlysincecominguponitwhiledoingresearchfortheChurchillLectures(Diamond,1994b).Theelementoftimeisachiefcauseofthosedifficultiesineconomicinvestigationswhichmakeitnecessaryformanwithhislimitedpowerstogostepbystep;breakingupacomplexquestion,studyingonebitatatime,andatlastcombininghispartialsolutionsintoamoreorlesscompletesolu-tionofthewholeriddle.…Themoretheissueisthusnarrowed,themoreDiamond_lect.indd22011-08-2910:45:00313exactlycanitbehandled:butalsothelesscloselydoesitcorrespondtoreallife.Eachexactandfirmhandlingofanarrowissue,however,helpstowardstreatingbroaderissues,inwhichthatnarrowissueiscontained,moreexactlythanwouldotherwisehavebeenpossible.Witheachstep…exactdiscussionscanbemadelessabstract,realisticdiscussionscanbemadelessinexactthanwaspossibleatanearlierstage.Thispassageisparticularlysuitableheresincetheheartofthedifferencebetweenstandarddemand-supplyanalysisandsearchtheoryliesinthetreatmentoftime–theuseoftimeaswellasresourcestolearnaboutopportunities.Iamconcernedthat,incontrastwithMarshall’sview,toomanyeconomiststakethefindingsofindividualstudiesliterallyasabasisforpolicythinking,ratherthandrawinginferencesfromanindividualstudy,combiningthemwithinferencesfromotherstudiesthatconsiderotheraspectsofapolicyquestion,aswellaswithintuitionsaboutaspectsofpolicythathavenotbeenformallymodeled.Assumptionsthataresatisfactoryforbasicresearch,forclarifyinganissuebyisolatingitfromothereffects,shouldnotplayacentralroleinpolicyrecommendationsifthoseassumptionsdonotapplytotheworld.Tome,takingamodelliterallyisnottakingamodelseriously.Itisworthrememberingthatmodelsareincomplete–indeedthatiswhatitmeanstobeamodel.Thisessayisnotasurveyofusesofsearchtheoryinanalyzingmanylabormarketquestionsorquestionsinothermarkets.2Instead,itexploresafewofthecontributionsofsearchtheory,focusingprimarilyonearlyworkthatmarkedthebreakfromanalyzingequilibriuminmarketstoanalyzingequilibriuminasearchsetting.Althoughthefocusisonthelabormarket,thediscussionstartswitharetailmarketexample,followedbydiscussionsoflabormarketflows,aggregatedemand,andtheBeveridgeCurve,whichshowsunemploymentandvacancyratesfortheeconomy.Considerableattentionhasbeengiventopossiblepolicyimplicationsoftherecentevolu-tionoftheBeveridgeCurve,duringwhathasbeencalledtheGreatRecessionandtheLongSlump.Iaddtothisongoingdebatefromasearchperspective.I.ARETAILMARKETEXAMPLEEconomicseducationstartswiththeabstractionofanidealmarket–demand,supply,andapricethatclearsthemarket.Thatisanextremelyvaluablestartingplace–itshowssomeoftheeffectsthatarepresentinprettymuchallmarkets.And,sincesuchidealmarketscanachieveefficientoutcomes,ithelpsusunderstandthesourcesofinefficienciesthatcanoccurwhenmarketstructuresdifferfromtheidealizedversion.Inthesimplemarketabstraction,eachbuyerknowshowtopurchaseatthelowestpriceavailableinthemarket.Asaresult,eachfirmfacesadiscontinuityinsaleswhenthepricevariesfromthelowestpriceelsewhereandthe“lawofoneprice”holds–alltransactionshappenatthesameprice,whichisthecompetitiveprice,equaltothemarginalcostofprovidingthegood.Toanalyzeasearchsetting,thefirststepistoconsiderhowindividualsDiamond_lect.indd32011-08-2910:45:00314approachboththesearchprocessandtheensuingpurchaseorsaledecision.Andthatiswheretheliteraturestarted.Butafullanalysisneedstocombineindividualdecision-makingwithananalysisofhowtheinteractionsofbu