Romer D. Advanced Macroeconomics

equilibrium unemplo~menrIS ~nefficientlyhigh or ineficiently low depends on whether y , rhc cxponenr on vacancies in the matching function (equation I9.68]), is more or less than $ (see Problem 9.17).

Such ambiguous w-elfareeffects are characteristic of economies where allocations are determined through one-on-oncmeetings rarhcr than through centralized markets. In our model, there is only one endogenous decisionfirms must decide whether to enter-and hence only one dimension along which the equilibrium can be inefficient. But in practicc, participants in such markets have many choices. Workefs can decide whether to enter the labor force, how intensively to look for jobs when rhey are unemployed, where to focus their search, whether lo invest in Job-specific or general skills when rhey are employcd, whether to look for a different job while they are employed, and so on. Firms face a similar array of decisions. Thcrc is no guarantee that the decentralized economy produces an efficient outcome along any of these dimensions. Instead, agents' decisions are likely to have externalities through direct effects on other parties' surplus or through effects on the effectiveness of the matching process, or both (see,for example, Mortenson, 1986).

This analysis implies that there is no reason to suppose that the natural rate of unemploymcnt is optimal. This obselvation provides no guidance, however, concerning whether observed unemployment is inefficiently high, inefficiently low, or approximately efficient. Iletermining which of these cases is correct-and whether there are changes in policy that would lead to efficiency-enhancing changes in equilibrium unemployment-is an important open question.

9.9 Empirical Applications

Contracting Effects on Employment

In our analysis of contracts in Section 9.5, we discussed two views or how employment can be determined when the wage is set by bargaining. In the first, a firm and its workers bargain only over the wage, and the firm chooscs employment to equate the marginal product of labor with the agreed-upon wage. Rut, as we saw, this arrangement is inefficient. Thus the second view is that the bargaining determines how both ernploymcnt and thc wage depend on the conditions facing the firnm. Since actual contracts do not spell our such arrangements, this ~ i c r assumesr that workers and the firm have some nuncontractual understanding that the firm will not treat the cost of labor as being given by the wage. For example, workers are likely to agree to lower wagcs in future contracts if the hrm chooses employment to cquatc the marginal product of labor nith the opportunity cost of workers' time.

Which of these vicws is corrccr t a i important implications. If firms choosc employment freely taking thc ;\ +e a, g i en,~ evidence that nominal wages are fixed for extended periods prr2\l'3rsdirect evidence that nominal disturbances have real effects. If thi 'rr-t is unimportant to employment