Fall 2010 Problem Set 2

Fall 2010 Problem Set 2 - Department of Economics...

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Department of Economics University of Maryland Economics 325 Intermediate Macroeconomic Analysis Problem Set 2 Professor Sanjay Chugh Fall 2010 Due: Thursday, December 9, 2010 Instructions : Written (typed is strongly preferred, but not required) solutions must be submitted no later than 2:00pm on the date listed above. You must submit your own independently-written solutions. You are permitted (in fact, encouraged) to work in groups to think through issues and ideas, but you must submit your own independently-written solutions. Under no circumstances will multiple verbatim identical solutions be considered acceptable. Your solutions, which likely require some combination of mathematical derivations, economic reasoning, graphical analysis, and pure logic, should be clearly, logically, and thoroughly presented; they should not leave the reader (i.e., your TAs and I) guessing about what you actually meant. Your method of argument(s) and approach to problems is as important as, if not more important than, your “final answer.” Throughout, your analysis should be based on the frameworks, concepts, and methods we have developed in class. There are two problems in total, each with multiple subparts.
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2 Problem 1: Search Theory and Labor Markets (60 points). The 2010 Nobel Prize in Economics was awarded to Peter Diamond, Dale Mortensen, and Christopher Pissarides for their development (during the 1970s and 1980s) of search theory. Search theory is a framework especially suited for studying labor market issues. The search framework builds on, but is richer than, the basic theory of supply and demand. Search theory can be applied to both the supply side of the labor market (building on the analysis of Chapter 2) as well as the demand side of the labor market (building on the analysis of Chapter 6). In what follows, you will study the application of search theory to the demand side of the labor market. There are three basic ideas underlying search theory. First, search theory incorporates into basic supply-and-demand analysis the fact that when a firm wants to hire a worker (i.e., “demands labor”), there is a chance that a suitable worker may not be found. That is, a firm “searching” for a worker has a probability less than one that a suitable “match” will be found. Second, search theory makes explicit the costs associated with search activity. As is realistic, when a firm wants to hire a worker, it does not simply “go to the market” as in basic supply-and-demand analysis. Rather, it must expend resources searching for a worker (think of these costs as the recruiting costs inherent in running a firm’s human resources department, placing job advertisements in various outlets, the interviewing process, etc.). Moreover, because of the various activities involved in the search, or “recruiting,” process, there is a time delay between when a firm engages in recruiting activities and when, if recruiting is successful, a new employee actually begins working at the firm. For concreteness, suppose that if a firm successfully recruited a new
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This note was uploaded on 09/07/2011 for the course ECON 325 taught by Professor Chugh during the Fall '08 term at Maryland.

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Fall 2010 Problem Set 2 - Department of Economics...

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