Question

Using the formal sequential search model described in the textbook, show graphically how each of the following events will impact the optimal level of the reservation wage of an unemployed job seeker with an infinite time horizon:

a) Job search becomes more costly.

b) The government increases unemployment benefits.

c) The variance of the wage offer distribution increases.

Answer 1

In a sequential model when the cost of searching for a job increases the level of reservation wage will become lower. This is explained by the graph:

The marginal utility of leisure is also impacted (remember the case where the wife won’t let the husband sit around all day doing nothing, he will now accept even a lower paying job)

B: If the government increases the unemployment benefits, this would increase the reservation wage of the person seeking the job. When getting unemployment benefits, we take under consideration the difference between the reservation wage and the unemployment benefit.

If we get 200€ as unemployment benefit and our reservation wage is 400€ then we have a 200€ “reason” to work. However if the benefits are increased to 300€, the difference lowers to 100€ and this is when you start considering whether it is worth to work for 100€ henceforth you increase the reservation wage to 450€ thus increasing the difference to 150€ (something more worth of getting you out of the couch)

C: Reservation wage increases with the increase of the wage offer distribution.

This can be observed in the formula Wmax=0.65 x n0.37x σ + Wmean - where a greater standard deviation (the red thingy) is directly related to a higher reservation wage (Wmax)