Deregulation shock in product market and unemployment

In a dynamic general equilibrium model with endogenous markups and labor market frictions, we investigate the effects of increased product market competition. Unlike most macroeconomic models of search, we endogenize the labor supply along the extensive margin. We find numerically that a model with endogenous labor force participation decision produces a decline in the unemployment rate which is almost three times larger than that in a model with fixed labor force. For a calibration capturing alternatively the European and the US labor markets, a deregulation episode, which lowers the markup by 3 percentage points, results in a fall in the unemployment rate by 0.17 and 0.05 percentage point, respectively, while the labor share is almost unaffected in the long-run. The sensitivity analysis reveals that product market deregulation is more effective in countries where product and labor market regulations are high, unemployment benefits are small and labor force is more responsive.