The Diamond, Mortensen and Pissarides Nobel: Search and market frictions

by Barbara Petrongolo
October 15, 2010

The 2010 Nobel Prize in Economics has been awarded to Peter Diamond, Dale Mortensen, and Christopher Pissarides "for their analysis of markets with search frictions". This column explains how their research relates to fundamental economic issues that are both at the core of the wellbeing of society at large and now near the top of many policymakers’ agendas.

Various forms of imperfections or “frictions” characterise most real-world transactions. The coexistence of buyers and sellers in a given market, who can in principle agree on a price, may not be sufficient for immediate trade, as both buyers and sellers may need to invest in a costly search process in order to locate matching partners, and eventually need to agree to enter a transaction rather than wait for better trading opportunities. These frictions derive from several sources, including imperfect information about trading partners, heterogeneous demand and supply, slow mobility, coordination failures and other similar factors. The importance these factors in driving market outcomes is a key issue for understanding such diverse markets as those for a job, a house, and a spouse.

The 2010 Nobel Prize in Economics has been awarded to Peter Diamond, Dale Mortensen, and Christopher Pissarides "for their analysis of markets with search frictions". Search theory provides a versatile framework for understanding market outcomes in a variety of situations in which trade is complex. One key lesson is that, with search frictions, markets fail to clear at all points in time – some buyers and/or sellers remain unmatched. Another important implication is that, when access to information is costly and trade opportunities are infrequent, not all traders may trade at the same market price, leading to dispersion in equilibrium prices. Finally, decentralised equilibrium may be inefficient in a search market, if individuals engage in “too much” or “too little” search, and in this case policy intervention may improve on what markets alone would be able to achieve.

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