Introduction to Modern Economic Growth physical to human capital ratio, κ∗ , has to be reached in equilibrium In other words, physical capital should not be too abundant relative to human capital, and neither should human capital be excessive relative to physical capital Consequently, this model does not allow equilibrium “imbalances” between physical and human capital either A possible and arguably attractive way of introducing such imbalances is to depart from perfectly competitive labor markets This also turns out to be useful to illustrate how the role of human capital can be quite different in models with imperfect labor markets 10.6 Physical and Human Capital with Imperfect Labor Markets In this section, we analyze the implications of labor market frictions that lead to factor prices different from the ones we have used so far (in particular, in terms of the model of the last section, deviating from the competitive pricing formulea (10.31)) The literature on labor market imperfections is vast and our purpose here is not to provide an overview For this reason, we will adopt the simplest representation In particular, imagine that the economy is identical to that described in the previous section, except that there is a measure of firms as well as a measure of individuals at any point in time, and each firm can only hire one worker The production function of each firm is still given by yj (t) = F (kj (t) , hi (t)) , where yj (t) refers to the output of firm j, kj (t) is its capital stock (equivalently capital per worker, since the firm is hiring only one worker), and hi (t) is the human capital of worker i that the firm has matched with This production function again satisfies Assumptions and The main departure from the models analyzed so far is that we now assume the following structure for the labor market: (1) Firms choose their physical capital level irreversibly (incurring the cost R (t) kj (t), where R (t) is the market rate of return on capital), and simultaneously workers choose their human capital level irreversibly 485