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.
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