Equilibrium Employment in a Model of Imperfect Labour Market

This paper presents a simple model of imperfect labor markets with endogenous labor market participation and home production. Labor market imperfections take the form of an irreversible entry cost incurred by workers which drives a wedge between the entry into the labor market and exit from the labor market. Labour force participation is thus described by two margins. This simple framework brings several results. First, it delivers an expression for the employment rate and as side-products, a measure of the unemployment rate and the size of the labour force. Second, it distinguishes between two types of non-employed workers: people without a job but willing to work at the equilibrium wage and people not willing to work. Third, it derives endogenously all flows between three labour market states. Fourth, a calibration of the model rationalizes differences in employment rates across selected countries by differences in the market productivity premium and the size of market frictions. Finally, the model is a very simple reduced form of search models with which it is fully consistent: the irreversible entry cost is the opportunity cost of search and depends on aggregate conditions.