EC-IILS Joint Discussion Paper Series No. 7

Dual labour markets with search costs

General equilibrium models with non-competitive labour market accounting for the dynamics of wages and employment have become increasingly used. For the most part, however, these general equilibrium models have been applied to advanced economies while the case of developing economies with dual labour market has been mainly addressed in partial equilibrium framework. This paper models an economy with an informal labour market along the line of the search and matching framework and revisits three main issues. The first issue is the dynamics of the informal sector over the business cycle. The second issue is the impact of informality on economic volatility. A third issue is the extent to which the interaction between dual labour markets modifies the standard properties of search models.