Decentralized wage setting in search equilibrium models is inefficient because the meeting firm and worker ignore the dependence of job-matching probabilities on the number of firms and workers engaged in search. This paper investigates whether risk-neutral monopolistic unions will have an incentive to internalize this externality. I find that the externality will be internalized only if the union's policy is chosen by unemployed persons. If employed persons influence union policy, both the union wage and unemployment will be too high. A tax on the union wage combined with an employment subsidy to firms can correct this inefficiency.

The traditional model of collective bargaining confines unions to settlements constrained by the employer's labor demand curve, but an alternative model places wage-employment outcomes on a contract curve that extends beyond the labor demand curve. This paper derives a multidimensional (hedonic) contract-curve model in which employment-security provisions are used to maintain efficient bargains outside the employer's demand curve and distinguishes empirically between the contract-curve and demand-constraint models using data for public school teachers in New York State. Estimates clearly support the contract-curve model over the demand-constraint model by linking the gap between compensation and the value of the marginal product to the strength of employment-security provisions.