November 2002

IZA DP No. 625: Endogenous Wage and Capital Dispersion, On-the-Job Search and the Matching Technology

This paper presents a new model of endogenous wage and capital dispersion where heterogeneity is driven by entrepreneurial incentives to pay higher wages in order to attract and retain workers. The main contribution of this model is to provide a framework with microeconomic foundations that give rise to matching frictions, which can be used to understand the dynamic features of job-worker flows, wage dispersion and mobility as well as search on the job. The basic model is also extended to endogenise firms’ optimal investment in job-specific capital and search efforts undertaken by both employed and unemployed individuals. The empirical implications of this model are compared to those of the apparently more tractable and indeed, more frequently used aggregate matching technology. Existing differences turn out to be crucial for the empirical identification of the wage offer distribution and may also bias subsequent inferences about underlying search cost parameters.