A Competitive Theory of Unemployment, Vacancies, and Labor Market Flows∗

This paper develops a dynamic competitive model of mismatch. Workers and jobs are randomly assigned to labor markets. Each labor market clears at each instant but some labor markets have more workers than jobs, hence unemployment, and some have more jobs than workers, hence vacancies. As workers and jobs move between labor markets, some unemployed workers find vacant jobs, some employed workers lose or leave their job and become unemployed, and some employed workers move to other jobs. The model is quantitatively consistent with two central features of labor markets over the business cycle, the Beveridge curve and the matching function. It can also address a variety of labor market phenomena, including duration dependence in the job finding probability, employer-to-employer transitions, and job creation and destruction