Classical economics assumes buyers and sellers meet instantly and prices clear the market. In reality, firms may post vacancies for a long time and job seekers spend weeks or months searching. The three laureates extended search and matching theory to explain why unemployment and vacancies can coexist when frictions are present. Their models quantify policy effects: for example, generous unemployment benefits lengthen search spells and raise unemployment. The theory also explains the empirical Beveridge curve, which helps distinguish cyclical from structural unemployment. Governments and central banks now rely on these insights when designing labor-market policy.

Diamond’s 1971 paper demonstrated that even tiny search costs can destroy competitive equilibria and yield monopoly-like pricing, launching formal research on market frictions. Mortensen and Pissarides extended this framework to a dynamic matching model in which workers and vacancies meet via a Poisson process, now known as the Diamond-Mortensen-Pissarides (DMP) model. In equilibrium, wages are set through Nash bargaining, and job flows, unemployment and vacancy rates are endogenously determined. Because the model contains externalities, private search effort need not be socially optimal, supplying a foundation for optimal taxation and unemployment-insurance design. The Beveridge curve’s position and slope shift with matching efficiency and labor-demand shocks; empirically, the elasticity of the matching function is a key parameter. Contemporary macro models incorporate financial frictions and skill mismatch within an extended DMP framework to study business cycles.

Diamond (1971) analysed a Bertrand environment with search costs, showing that for any ε>0 the equilibrium price converges to the monopoly level, the so-called “Diamond paradox.” Mortensen & Pissarides (1994) formulated a continuous-time model with a Cobb-Douglas matching function M(u,v)=Au^α v^{1−α}, deriving the law of motion for employment with endogenous job creation and destruction; Nash-bargained wages collapse to w=βθp+(1−β)z. Because of search externalities, the planner’s solution entails hiring taxes or search subsidies and can be cast as a Ramsey optimal-control problem. Empirically, Shimer (2005) highlighted the volatility puzzle, prompting subsequent fixes such as alternative bargaining protocols (Hall-Milgrom 2008) or high match surplus calibration (Hagedorn-Manovskii 2008). Current research integrates the DMP block into Heterogeneous Agent DSGE models with terminal value functions and redistribution, refining equilibrium concepts.