Search Theory and Unemployment
You must understand the search and matching theories of unemployment in the context of other theories of unemployment. With this objective in view, we classify, in this section, the theories of unemployment that we are studying into four kinds. If there is unemployment in a Walrasian labour market, unemployed workers would immediately bid down wages until supply and demand for labour are again in balance. If this process of bidding down wages is not working freely, there must be distinct reasons for it. We classify the theories of unemployment according to whether the process of wage adjustment is working or not, and according to the reason why it is not working in cases where it does not work. In particular, consider an unemployed worker, who claims to be identical to a firm's current workers, and who offers to work for the firm at a marginally lower wage than the one the firm is currently paying to its workers. There are four possible responses of the firm, giving us four kinds of theories of unemployment. These responses are:
i) If the firm accepts the worker's offer, we can conclude that the market for labour is Walrasian. In this view all observed unemployment is voluntary unemployment - unemployment of people moving between jobs and of those who are ready to work only at wages higher than the prevalent wage rate. This is really the neoclassical model of unemployment referred to above.
ii) Secondly, the firm can respond to the unemployed worker's offer by saying that it does not accept the premise that the unemployed worker is identical to the firm's current employees. In this view, the labour market is not a market for a homogenous commodity, but is characterised by heterogeneity. Each job is unique and requires the unique skills that are embodied in an individual. The unemployed workers are matched with existing vacancies not through the market, but through a complex process of search and match. The models of unemployment that postulate such a process are called search and matching models.
iii) Thirdly, the firm can respond by saying that, even though it would like to cut the wages and employ the additional worker, it cannot do this because it is bound by implicit and explicit agreements with its workers, arrived at through collective bargaining, regarding the wages that have to be paid. Wages are thus institutionally determined in these models know as contracting models.
iv) Lastly, the firm may respond by saying that it does not want to,reduce real wages - it believes that the benefits accruing to it from higher wages are more than the costs of maintaining wages high. Theories that build up on this idea are called eflciency-wage theories in an obvious reference to the fact that higher wages impart benefits to the employing firm by improving the efficiency of labour.