DIMINISHING RETURNS AND LABOR MARKET ADJUSTMENTS

Ha Dao and Alain Delacroix

Macroeconomic Dynamics, 2018, vol. 22, issue 8, 2088-2106

Abstract: We amend the canonical matching model by assuming diminishing returns to labor. We put the model to the twin test of generating a high volatility of labor market variables in response to productivity shocks (the “Shimer puzzle”) and a moderate response to changes in unemployment benefits and find that it passes that test. It does not feature wage rigidity, nor is it based on a small surplus calibration. Diminishing returns introduce a distinction between marginal and average surplus. With a standard (large average surplus) calibration, we can have a small marginal surplus, and thus a strong response of hiring to productivity shocks, while obtaining a measured response of unemployment to changes in benefits.

Date: 2018
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