DP1572 | Efficient Wage Dispersion

Publication Date

21/02/1997

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Abstract

In market economies identical workers appear to receive very different wages, violating the ?law of one price? of Walrasian markets. It is argued in this paper that in the absence of a Walrasian auctioneer to coordinate trade: (i) wage dispersion among identical workers is very often an equilibrium phenomenon; and (ii) such dispersion is necessary for a market economy to function. The paper analyses an environment in which firms post wages and workers may, at a small cost, observe one or more of the posted wages, i.e. search, before deciding where to apply. Both with homogeneous and heterogeneous forms, equilibrium wage dispersion is necessary for the economy to approximate efficiency. Without wage dispersion, workers do not search, and wages are depressed. As a result: (a) there is excessive entry of firms; and (b) because, in the absence of search, high-productivity firms cannot attract workers faster than low-productivity firms, their relative profitability is reduced, and technology choices are distorted.