Using directed search to model the product market and the labor market, I show that large plants can pay higher wages to homogeneous workers and earn higher expected profit per worker than small plants, although plants are identical except size. A large plant charges a higher price for its product and compensates buyers with a higher service probability. To capture this size-related benefit, large plants try to become larger by recruiting at high wages. This size-wage differential survives labor market competition because a high wage is harder to get than a low wage, Moreover, the size-wage differential increases with the product demand when demand is initially low and falls when demand is already high.
All Science Journal Classification (ASJC) codes
- Economics and Econometrics