Relative Prices in a Frictional Labor Market

Michael Lim

No 2014-E22, GSIA Working Papers from Carnegie Mellon University, Tepper School of Business

Abstract: Empirical data suggests that the relative price of goods and services may play a role in individual labor supply decisions. Data shows that individuals spend a significant amount of their time at home engaged in activities such as child care, education, and elderly care, among others, which are substitutible with relatively expensive market services. From 2000 and onward, the relative price of services and the labor participation rate have shown a negative relationship. In this paper, the role of relative prices in a frictional, two sector labor market is examined. Adapting the labor search model presented in Garibaldi and Wasmer (2005) to incorporate relative price effects, we show that the introduction of relative prices has both partial and general equilibrium effects on entry and exit margins, which tend to reduce labor market participation. The model is then calibrated and taken to US data from the 2000s (to be done).

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