Firm Entry and Labor Market Dynamics

Enchuan Shao and Pedro Silos
Working Paper 2008-17
August 2008

Download the full text of this paper (362 KB) PDF icon

We present a model of aggregate fluctuations in which monopolistic firms face sunk costs to enter the production process and labor markets are characterized by search and matching frictions. Entrants post vacancies and are matched to idle workers. Our specification of sunk costs gives rise to a countercyclical net present value of a vacancy; it is always zero in models where entry is free. The model displays a strong degree of amplification and propagation. The time-varying value of a vacancy has implications for the surplus division between firms and workers over business cycle. In the data, we proxy this division using the ratio of corporate profits to output and workers' compensation to output. We document the cyclical behavior of profit's and labor's shares: Profit's share leads the cycle and is procyclical and more volatile than output. Labor's share inversely leads the cycle and is weakly countercyclical and smoother than output. Our model is consistent with the cross-correlations of both shares and the higher volatility of the share of profits. Regarding propagation and amplification, the model matches the persistence of vacancy creation and two-thirds of the observed volatility of market tightness relative to output.

JEL classification: E24, E32, J32

Key words: search, matching, business cycles, income shares

The authors thank Jim Costain and Ruben Segura-Cayuela for discussions at the early stages of this project. They also received useful comments from participants at seminars at the University of Iowa, Florida State University, the Federal Reserve Bank of Atlanta, Midwest Macroeconomics meetings, Nicole Baerg, and Federico Mandelman. They especially thank B. Ravikumar and Gustavo Ventura. The views expressed here are the authors' and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.

Please address questions regarding content to Pedro Silos, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street, N.E., Atlanta, GA 30309, 404-498-8630, 404-498-8956 (fax),, or Enchuan Shao, Department of Economics, San Francisco State University, 1600 Holloway Avenue, San Francisco, CA 94132.

For further information, contact the Public Affairs Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street, N.E., Atlanta, Georgia 30309-4470, 404-498-8020.