Equilibrium Unemployment in a Generalized Search Model

We present a generalization of the standard Diamond-Mortensen-Pissarides undirected-search model of unemployment in which the hiring process is time-consuming as well as costly. We follow Stole and Zwiebel (1996a,b) and assume that wages are determined by continuous bargaining between the firm and its employees. This generates a non-trivial dispersion of firm sizes; when firms' production technologies exhibit decreasing returns to labor, it also generates wage dispersion, even though all firms and all workers are ex ante identical. We characterize the steady-state equilibrium of the model; some important special cases are characterized in closed form. We characterize the out-of-steady state dynamics of employment and wages of the economy in response to productivity shocks. A feature of the model is the ability of the economy to respond to shocks on both an intensive margin (a change in the intensity of vacancy posting of incumbent firms) as well as an extensive margin (a change in the number of active firms); we show that both margins, as well whether there are decreasing returns to labor at the firm level, are important for the qualitative behavior of the unemployment rate and of the distribution of employment and wages across firms.