long-term unemployed during their jobless time.8 If the average, endogenously de-
termined duration of unemployment increases, increased long-term unemployment is
implied. Furthermore, increasing technical progress induces rising long-term unem-
ployment, since long-term unemployed do not possess the know-how and the abilities
to handle the latest production methods.
For attaining the steady-state solution and the determinants of the equilibrium
level of long-term unemployment, an efficient factor allocation function and a bal-
anced accumulation function are derived. The first mentioned function which is
implied by the intertemporal demand decisions of firms characterizes labor market
structures and describes the optimal factor allocations in the labor market. As long
as the labor market has not reached the long-run equilibrium, structures will change
permanently. This is reflected by differences in inflows and outflows and by a perma-
nently changing level of long-term unemployment. The second mentioned function
represents the steady-state of the goods market and characterizes the growth process
of the economy. In long-run equilibrium all relevant variables grow with the same
rate and the vacancy level as well as the share of long-term unemployment have
reached long-run positions.
The Labor Market
The aggregate labor endowment of households is constant and denoted by L = L.
At any time labor is either employed or unemployed; the employed workers are
denoted as E and the unemployed as U. Thus, the labor force is represented by
L = E + U. (1)
The labor market is characterized by search frictions with firms looking for job-
less workers filling vacancies and unemployed searching for a job. Both sides of the
market have incomplete information about the opposite market side. The level of
search activities is represented by the number of vacancies V, the number of unem-
ployed U and the number of matches M formed at any point in time. Furthermore,
since newly created vacancies are endowed with the most recent technology, the
number of matches is also determined by the rate of technological progress λ rep-
resenting the diffusion of technological know-how. If an economy has a high rate
of technological progress, only few unemployed workers can fill the vacancies and
the number of matches is relatively low. In order to represent this, it is assumed
8See Layard (1997).
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