Posted by: Dirk | January 12, 2009

Edmund Phelps on a island, looking for work

Then the islands where money wage rates are above the average money wage rates expected elsewhere will be numerous enough relative to the islands where wage rates are below expected wage rates elsewhere that the equilibrium steady unemployment rate (at which, on average, money wage rates move as expected) will be positive.

This is from a Phelps (1969) article, which deals with incomplete information on labor markets. Phelps uses the example of some islands to explain the costs of job search and information. Since jobs are available on different islands, you have to spend a day of travel to either check out the job market of the next island or get information on the current wage rate there. Only then you can validate your expectations of wages and prices. Based on this information you might be willing to accept a job at the going rate or travel somewhere else (or return) to get a better paid job. Shifts in aggregate demand disturb the expectations of people, but since the central bank can influence money wage rates, it has a certain level control over the job market.

It is a very insightful paper, don’t be scared by the sentence above.

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