Seminar Papers,
Stockholm University, Institute for International Economic Studies

Abstract: Workers are embedded within a network of social relationships and can communicate through word-of-mouth. They can find a job through either formal agencies or 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. Search frictions arise endogenously because of coordination failures between workers as in the standard urn-ball model. However, contrary to the latter, the network of personal contacts allows here for a (partial) replacement of redundant jobs. Therefore, introducing word-of-mouth communication among network-related individuals reduces co-ordination failures and alleviates the associated search frictions. In particular, 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. Finally, we show the existence and uniqueness of the labor market equilibrium and study its properties. In dense enough networks, the corresponding equilibrium unemployment rate increases with network size.

Keywords: coordination failures; microfoundation of the matching function; social network; personal communication

JEL-codes: D83; J64

39 pages, May 22, 2001

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