published in: Journal of Urban Economics, 2005, 57 (3), 500-522
Workers are embedded within a network of social relationships and can communicate
through word-of-mouth. They can find a job either directly or through personal contacts. From
this micro scenario, we derive an aggregate matching function that has the standard
properties but fails to be homogeneous of degree one because of coordination failures
between workers. We show that, when the network size increases, on average, the
unemployed workers hear about more vacancies through their social network but, at the
same time, it is more likely that multiple vacancies reach the same unemployed worker.
Above a certain critical value, this job overcrowding becomes so important that job matches
decrease with network size. We then establish existence and uniqueness of the labor market
equilibrium and study its properties. In dense enough networks, the equilibrium
unemployment rate increases with network size whereas the latter has an ambiguous effect
on wages. Finally, we demonstrate that the decentralized market equilibrium is not efficient
because of both search and network externalities.
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