What is search theory?
Search theory is a study of transactional friction between two parties and prevents them from finding an instant match.
- Search theory describes how buyers and sellers decide when to accept a matching offer in a transaction.
- Search theory extends economic analysis beyond the idealized world of perfectly competitive markets.
- Search theory helps explain why frictional unemployment occurs when workers look for jobs and companies look for new employees.
Understand search theory
Search theory has been used primarily to explain the inefficiencies of the employment market, but is widely applied to all forms of “buyers” and “sellers”, whether they are products, homes, or even spouses / partners. I can do it. Under the classic competitive equilibrium model, buyers and sellers can trade in a frictionless world with complete and open information. The clearing price will be met quickly as the power of supply and demand reacts freely. But in the real world, this doesn’t happen. Search theory tries to explain how.
In the real world, information is incomplete and costly, transactions contain individual quantities of goods and services, and buyers and sellers can be separated by space or other barriers. In other words, the parties who want to do business with you, the employer and the job seeker, or the seller and the buyer of the goods, encounter friction when looking for each other. These frictions can take the form of inconsistencies in geographic conditions, price expectations, specification requirements, and delays in response and negotiation time by one of the parties involved. Government or corporate policies can further impede an efficient search process.
Search theory was originally applied to the labor market, but it has been applied to many subjects in economics. In the labor market, search theory is the basis for explaining frictional unemployment when workers change jobs. It is also used to analyze consumer choices between different products.
In search theory, a buyer or seller faces a set of alternative offers of different qualities and prices, and a set of preferences and expectations that decide whether to accept or reject. All of these can change over time. For workers, this means work wages and allowances combined with working conditions and work characteristics. For consumers, it means the quality of a product and its price. In both cases, the search depends on their preference for price and quality and their beliefs about other possible options.
Search theory describes the best time a searcher spends on a search before deciding on one option to accept. Search time depends on several factors.
- Reservation price: The personal booking price is the minimum value they are willing to accept / the maximum value they are willing to pay. For example, a buyer who has a fixed budget of $ 5,000 in cash to spend on a car will search for less than $ 5,000 for enough time to find a car of the right quality. Welfare and unemployment allowances may induce qualified workers to sit at home and collect unemployment checks instead of looking for a job, as they raise retained wages.
- Costly search: Optimal search times tend to be shorter as the cost increases with the length of the search. For example, if a worker’s skills can decline or become obsolete over time, they tend to shorten the search for new jobs.
- Price and quality difference: The amount of variation in price and offer quality also affects the optimal search length. Larger variations can persuade seekers to last longer in search, hoping to find better alternatives.
- risk avoidance: Risk aversion can also affect search time. For example, longer job hunts often run out of savings for searchers, and longer searches can increase the risk of poverty. Risk-averse seekers tend to shorten their searches under these conditions.
Economists Peter Diamond, Dale Mortensen and Christopher Pisalides won the 2010 Nobel Prize in Economics for their analysis of search-friction markets, including simultaneous searches by both buyers and sellers. Their theory is a basic empirical observation that there can be many unemployed job seekers (as opposed to unemployed who are not looking for a job) when there are many suitable jobs for them. I was confused.
Diamond began a search theory study of the retail market, and Mortensen and Pisalides focused on the labor market. The discovery of friction, which leads to suboptimal results, helped explain the chronic unemployment problem, the difference between prices and wages, and the inefficient use of search resources. Second, their search theory findings provide policy makers with guidance to coordinate unemployment programs to optimize benefit payments and promote more consistent activities between job buyers and sellers. increase.