Targeted search, endogenous market segmentation, and wage inequality

We develop a labor search/matching model with heterogeneous workers (a continuum of types) and heterogeneous firms (a finite number of types). One novel feature of our model is that search is targeted: each type of firm constitutes a distinctive submarket, and workers are able to choose in which submarket to participate beforehand, but search is random within each submarket, and wages are determined by Nash bargaining. We show that there is always a unique equilibrium, and the equilibrium matching pattern is weakly positive assortative. Our model is tractable enough to study how shocks, including a skill-biased technical change in some high-productivity submarket and a decrease in the number of jobs in some low-productivity submarket, affect the equilibrium segmentation pattern and wage inequality. In particular, we show that an Internet-induced increase in search efficiency would reduce the number of workers participating in higher-productivity submarkets, increase wage inequality within each submarket (workers with similar jobs), and also increase overall wage inequality across submarkets.