UNEMPLOYMENT AND MARKET SIZE

Without strong empirical support, labour market matching models typically assume constant returns to scale in matching. We construct a tractable equilibrium random matching model with a general matching technology, introducing market size effects: the job-finding rate varies with unemployment. Stable steady-states may occur in regions of increasing or decreasing returns, and multiple equilibria are welfare-ranked by market size. While the standard model relies on high-frequency shocks to the steady state to explain the co-movement of unemployment and job-finding, locally decreasing returns in matching generate plausible adjustment dynamics and slower convergence. Lastly, an extension of the Hosios condition internalises search externalities.