We examine an endogenous growth model in which market frictions are an integral part of the economic environment. Workers invest in education when young, which raises their productivity once employed. The level of schooling also acts as a key determinant of the rate of economic growth by influencing workers' ability to accumulate additional human capital on-the-job. Once schooling is completed, workers search for employment. The division of the surplus between vacancies and searching workers is characterized, as is the optimal level of education. The economy may display multiple steady-state growth paths.

Just how important a determinant of economic growth is the efficacy with which markets are organized? It is clear that in order to answer this question it is necessary to have both a well-articulated theory of economic growth and a precise notion of what it means for one market to be better organized than another. The newly developed theory of endogenous growth (pioneered by, among others, Paul M. Romer [1986], Robert E. Lucas [1988], Nancy Stokey [1988], and Gene Grossman and Elhanan Helpman [1991]) has equipped economists with a rigorous microeconomic foundation of the growth process. Since its original inception, research in this area has bifurcated: one strand of work has continued to emphasize the importance of capital accumulation (both physical and human) in environments in which agents are competitive price-takers; the other strand has a distinctly neo-Schumpeterian flavor, in which firms are price-setters and purposive innovative activity leads to technological advancement. But what of the role played by market organization? The growth literature has remained relatively silent on this issue. The reason is that the canonical growth model is one in which trade-either competitive or monopolisticly competitive-is coordinated by the Walrasian auctioneer. Given that ex hypothesi trade is frictionless, it is meaningless to use this framework to discuss issues pertaining to improvements in market organization. However, beginning with the seminal contributions of Peter Diamond (1982), Dale T. Mortensen (1982), and Christopher Pissarides (1985), economists have begun to construct models that dispense with the auctioneer's coordinating function. In this setting it is possible to make precise the notion of an improvement in market efficacy, since search and bargaining frictions are explicitly incorporated as an integral part of the trading environment. Yet, it is only very recently that this literature has begun to explore the consequences for perpetual economic growth.