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 mar- gin. 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 European and the U.S. labor markets, a deregulation episode, which lowers the markup by 3 percent- age points, results in a fall in the unemployment rate by 0.17 and 0.07 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 labor market regulation is high, product markets are initially highly regulated, unemployment benefits are smaller and labor force is more responsive.