A Theory of Factor Shares

Sephorah Mangin

No 19-14, Monash Economics Working Papers from Monash University, Department of Economics

Abstract: This paper presents a theory of how factor income shares are determined in an environment with labor market frictions and heterogeneous firms. I assume neither a specific aggregate production function nor competitive factor markets. Instead, I first develop microfoundations for an aggregate production function that incorporates a frictional process of matching workers and firms. Wages are determined by Bertrand style competition between firms whose productivity levels are assumed to be Pareto-distributed. In the limiting case where the unemployment rate goes to zero, the aggregate production function is Cobb-Douglas and factor shares are constant. In general, however, the behavior of factor shares is driven by labor market conditions such as unemployment and workers' reservation wage. I simulate the model and examine its predictions for factor shares in the U.S. during the period 1951-2010. The theory can explain much of the variation in factor shares from 1951 to 2003 but the sharp fall in labor's share in around 2004-2005 remains puzzling.

Keywords: Labor share; factor shares; aggregate production function; matching; unemployment; reservation wage; Cobb-Douglas; Pareto distribution; labor market frictions (search for similar items in EconPapers)
JEL-codes: D33 E23 E24 E25 J64 (search for similar items in EconPapers)
Pages: 60 pages
Date: 2014-04
New Economics Papers: this item is included in nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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