This paper presents a dynamic labor market model that describes the mechanisms through which individuals and firms take decisions regarding the supply of and the demand for formal and informal labor as a function of the prevailing market wage rates and other parameters. There are also presented the determinants and the characteristics of formal and informal labor supply schedules. The authors reach the conclusion that higher formal employment demands higher informal wages, ceteris paribus. Analyzing the formal and informal labor demand schedules, the conclusion is that higher formal employment levels result in higher reservation productivity, and vice versa, ceteris paribus. There are also analyzed the formal and informal employment equilibrium paths. (*The research was financed through a grant by the CERGE – EI foundation under a program of the Global Development Network. Additional funds for grantees have been provided by the Austrian Government through WIIW, Vienna).