In this study, a detailed model is presented to incorporate the labor markets in the West Bank/Gaza Strip (WBGS) with macroeconomic variables such as private investments and capital government expenditures. The estimated model will be utilized to conduct macroeconomic simulations to trace out the evolution of unemployment, the allocation of labor between local markets and Israel. According to Oslo Accords, the returning population is assumed at 1.5 million at a minimum, representing the resident of refugee camps in Jordan, Syria and Lebanon and refugees located in the low income areas in these countries. It is anticipated that applying intensive investment programs with external transfers under free trade conditions are promising mechanisms to absorb over-supply of labor originating from Palestinian workers in Israel and returning Palestinian workers from abroad in the local economic sectors. The key message coming from this paper is the centrality of investment in tradable sectors (both exportable and import-substitutes) is needed to absorb the growing labor supply. That in turn requires a policy environment, which fosters private investment.