Unemployment in an Interdependent World



The wage curve is an increasing function of θ since workers have more power to hold-up
the firm when the labor market is tight and the costs of a break-down of negotiations are
high for firms.

The equilibrium real wage wi /Pi and labor market tightness θi are found by interacting
the wage curve with the job creation curve. A central feature of both the wage and the job
creation curves is that their intercept in (w
i/Pi, θi) -space is proportional to Φi. In the
wage curve, this simply reflects the fact that unemployment benefits are by assumption
a share of the marginal value product of labor. More interestingly, the job creation curve
depends on Φ
i because more productive firms spend a smaller fraction of their revenue
on flow fixed costs f
ij , which are denominated in units of the final output good, and a
larger fraction on labor. Hence, the reallocation of workers towards more productive firms
increases the demand for labor.

We can now state a first Lemma.

Lemma 1 [Labor market equilibrium]

(a) For given aggregate productivity Φi, there is a unique labor market equilibrium {wi/Pi, θi}
if σ-lr > bi.

σ-βi    i

(b) Wages are constant over firms.

(c) A decrease of Φi lowers the real wage wi/Pi and the degree of labor market tightness
θ
i.

(d) For given Φi, variation in institutional parameters bi, ci or mi leads to qualitatively
equivalent results as regards the degree of labor market tightness θ
i.

The Lemma shows that labor market outcomes can be entirely characterized once
aggregate productivity Φ
i is known. That variable summarizes the stance of the en-
tire productivity distribution and the number of available varieties. Trade liberalization
can only affect labor markets through this variable. Also, institutional changes in other
countries will affect domestic labor markets through Φ
i .

Part (a) in Lemma 1 follows from the fact that the job-creation curve is strictly
downward sloping in
θi , while the wage curve is upward-sloping. An equilibrium exists
only if the flow-value of non-employment
bi is smaller than the share of the value of the
match that will accrue to the worker.

Part (b) implies that workers are paid similarly across firms with different productivity
levels. As in Stole and Zwiebel (1996) firms exploit their monopsony power until employees
are paid their outside option. This property of the model is a fairly general feature of
Krugman/Melitz-type models.
12

Part (c) holds true under the condition established in part (a). Figure 1 illustrates
this effect. The intuition is that any change in Φ
i must have a smaller effect on the flow
value of non-employment (b
iΦi) than on the flow value of employment σ-1 Φi; otherwise,
no worker would be willing to seek employment. Hence, a reduction in Φ
i sihifts the wage

12See, e.g., Eckel and Egger (2009) for an analysis of unionized labor markets framework without search
frictions, and Felbermayr, Prat, and Schmerer (2008) for the case of firm-level collective bargaining in
the presence of search frictions.

11



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