2013, ‘A theory of aggregate supply and aggregate demand as functions of market tightness with prices as parameters,’ NBER WP

This article develops a model of unemployment fluctuations. The model keeps the architecture of the general-disequilibrium model of Barro and Grossman (1971) but takes a matching approach to the labor and product mar-kets instead of a disequilibrium approach. On the product and labor markets, both price and tightness adjust to equalize supply and demand. Since there are two equilibrium variables but only one equilibrium condition on each market, a price mechanism is needed to select an equilibrium. We focus on two polar mechanisms: fixed prices and competitive prices. When prices are fixed, aggre-gate demand affects unemployment as follows. An increase in aggregate demand leads firms to find more customers. This reduces the idle time of their employees and thus increases their labor demand. This in turn reduces unemployment. We combine the predictions of the model and empirical mea-sures of product market tightness, labor market tightness, output, an