3 win Economics Nobel for ‘search theory'

Prof Peter A. Diamond of the Massachusetts Institute of Technology, Prof Dale T. Mortensen of Northwestern University and Prof Christopher A. Pissarides of the London School of Economics have been awarded the Bank of Sweden Prize or the Nobel Prize in Economics for 2010 for their work on “search theory”.

An arcane branch of modern economics, search theory deals with optimal choices.

It has been applied to labour markets where people are looking for jobs and to consumer theory where people are buying things.

The point about such searches is that what a person finally decides depends on what he or she believes are the alternatives available.

So, what happens is that he or she will delay a decision until it becomes too costly to search any further.

A part of the problem is also that buyers don't know fully what is on offer and sellers don't know that there is someone who will buy. This applies to jobs as well as products.

The three economists who have won the prize have created a theoretical framework for search markets.

In the case of labour markets, an important insight is that if unemployment benefits are too generous, the person receiving such benefits will keep delaying accepting job offers, thus pushing up the unemployment rate as also acting as a burden on the exchequer.

This has been known to often happen in Scandinavian countries.

Another important insight comes from the question, “why should the same goods be sold at more than one price?”

Given perfect information, everyone will buy at the same price. But information is not perfect in that the same information is not available to everyone.

Matching theory

Profs Diamond, Mortensen and Pisarides have also a theory called matching theory. One insight from this theory is that because optimal searches take time, everyone who has lost his or her job will go through a period of being unemployed while looking for the best suited job.