Lecture3
Lecture3
Adrien Bilal
Spring 2024
Harvard
Introduction
Recap: The DMP Model
• When study a policy, need to specify what the market failure is!
I Unless about pure redistribution
I Without market failure, welfare theorems hold
I No need for any intervention (except redistribtuion)
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Setup
Constrained Efficiency
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Planning Problem
Planner’s Problem (1/2)
∞
X
max E0 β t Ct
{Ct ,vt }t ,
t=0
s.t. Ct = zt (1 − ut ) + ut b − cvt
ut+1 − ut = s(1 − ut ) − f (vt /ut )ut , u0 given
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Planner’s Problem (2/2)
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Planner’s Optimality Conditions (1/2)
• Use value function of planner:
• Obtain
∂M ∂Ω 0 0
c = −β (ut , vt )Ez (u , z )
∂v ∂u
∂Ω ∂M ∂Ω 0 0
(u, z) = b − z + β 1 − s − (ut , vt ) Ez (u , z )
∂u ∂u ∂u
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Planner’s Optimality Conditions (2/2)
• Define the planner’s surplus from a job as S(u, z) = −∂u Ω(u, z)
c = (1 − α)βqt Et St+1
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Efficiency
(In)Efficient Vacancy Creation
• Differences between planner and equilibrium are:
I The vacancy creation condition
• Intuition
I Both firms (and workers) congest the matching function for other searchers
v ∂M
I For firms: M ∂v
=1−α
I How much firms internalize congestion depends on surplus share 1 − γ
I Efficient when firms’s surplus share equals their technological congestion effect
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When is Unemployment Too Low or Too High? (1/2)
• Focus again on steady-state zt ≡ z and approximation s, r f :
1−γ z −b 1−αz −b
θDE ≈ vs. θSP ≈
γ c α c
s
and recall u ≈ mθ 1−α
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Optimal Policy
Labor Taxes
• Now return to the decentralized equilibrium
• Optimal tax
α−γ
τt = zt − b + θtDE c
1−γ
• In practice need to
I Know α, γ
I Know zt , b, c
I Measure θt
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Taking Stock
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Composition Externalities
Setup
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Values
• Value of unemployment now
X
Ut = b + βEt ft ωj (vv t )Ej,t+1 + (1 − ft )Ut
j
where
M i vi
ωi (vv ) = P
j M j vj
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Job Creation
• In steady-state
X
Si = zi − b + β(1 − s)Si − βγf ωj Sj
j
ci = βq(1 − γ)Si
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Planner’s Problem
• Planner’s state variable is now employment at each type
I In homogeneous model could equivalently use unemployment
I Denote vectors with bold font: (n1 , ..., nI ) ≡ n and (v1 , ..., vI ) ≡ v
• Obtain
X Mj vj 0
n0 , z 0 ) + β n0 , z 0 )
ci (vi ) = βq(θ)Ez ∂ni Ω(n q (θ)Ez ∂nj Ω(n
j
u
0 0
n, z )
∂ni Ω(n = zi − b + β (1 − s) Ez ∂ni Ω(n n ,z )
X Mj vj 0
n0 , z 0 )
+ q (θ)θEz ∂nj Ω(n
j
u
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Planner’s Solution
• In steady-state:
X
Si = zi − b + β (1 − s) Si − βαf ωj Sj
j
n X o
ci = βq Si − α ωj Sj
j
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Surpluses and Job Creation
• Compare steady-state match surplus in eq. Si vs. in planner’s solution Si
X
Si = zi − b + β(1 − s)Si − βγf ωj Sj
j
X
Si = zi − b + β (1 − s) Si − βαf ωj Sj
j
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Direction of Composition Externality
• Compare job creation conditions under Hosios condition
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Taking Stock: Composition Externalities
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Competitive Search
Endogenous Labor Market Segmentation
• Firms internalize that posting a higher wage may attract more applicants
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Endogenous Labor Market Segmentation
• Value of unemployment if search in market with wage w
U(w ) = b + β [f (w )E (w ) + (1 − f (w ))U(w )]
• E (w ) as before
U(w ) ≡ U ≡ max
0
U(w 0 ) =⇒ f (w ) [E (w ) − U] ≡ Λ
w
S = z − b + β(1 − s)S − βΛ
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Firm’s Problem (1/2)
• Trade off
I Higher wage/lower profits (J(w ) ↓)
I Hiring workers faster (q(w ) ↑)
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Firm’s Problem (2/2)
1 α
max (mΛ−α ) 1−α J (S − J) 1−α
J
• Solution
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Bringing Back Heterogeneity
• Solution
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Composition Externalities
• No composition externalities
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Taking Stock
• Competitive search makes search economy efficient
I Irrespectively of homogeneity or heterogeneity
I Also called directed search
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Bonus: Segmented Markets
Segmented Markets
• Suppose now that labor markets are also segmented by firm type i
I Now can use either linear or convex job creation costs
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Equilibrium Values with Segmented Markets
• Value of unemployment if search in market i
γfit Et Si,t+1 = Λt
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Planning Problem
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Efficiency With Segmented Markets
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Taking Stock
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