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Monday, October 11, 2010

The 2010 Nobel Prize in Economics

The three winners are Peter A. Diamond, Dale T. Mortensen, and Christopher A. Pissarides for their work on the theory of unemployment. For rundowns of the contributions of these three men, see Tyler Cowen’s (somewhat technical) posts at Marginal Revolution.

Tyler Cowen’s co-blogger, Alex Tabarrok, summarizes the prize thus:

The 2010 Nobel Prize awarded to Peter A. Diamond, Dale T. Mortensen, Christopher A. Pissarides can be thought of as a prize for unemployment theory.

A key breakthrough was to realize that the problem was not how to explain unemployment per se but rather how to explain hiring, firing, quits, vacancies and job search and to think of unemployment as the result of all of this underlying microeconomic behavior.  Notice that the underlying behavior involves not just workers looking for jobs but also employers looking for workers so explaining unemployment would require a theory of job search, worker search and matching and each aspect of the theory would have to be consistent with every other aspect; i.e. how much workers search depends on how much employers are searching (e.g. advertising) and vice-versa and also on the quality of matching and all of these considerations need to be addressed together.  It was Mortensen and Pissarides in particular, building on work by Diamond, who built just such a consistent model.

A very surprising empirical fact helped to motivate this perspective: even in a recession millions of jobs are being created every month.  The figures we usually hear about the number of jobs created is the net figure but in the United States in August, for example, there were 4.1 million hires (and 4.2 million separations).  Thus, as noted above, understanding unemployment requires understanding these much larger flows of job creation and destruction.

Calibrating the (Diamond)-Mortensen-Pissarides model and embedding it in a dynamic real business cycle model to see if it can match the facts has been a key aim of recent work (see also here and Robert Shimer’s work).

Search theory has been applied extensively to the labor market but the same type of theory can be used to understand any issue in which matching is important such as marriage markets and the housing market.

PS: President Obama nominated Diamond to the Fed’s board of governors, but the Senate returned his nomination. Fed Chairman Ben Bernanke was once a student of Diamond’s.

  • Sheldon Richman is the former editor of The Freeman and a contributor to The Concise Encyclopedia of Economics. He is the author of Separating School and State: How to Liberate America's Families and thousands of articles.