Labor Market Discrimination, Pay Inequality, and Effort Variability: An Alternative to the Neoclassical Model

In model presented in this paper, once one allows for effort variability that is positively related to labor compensation, relatively low wages that are a product of labor market discrimination can persist over time even in a world of perfect product market competition. Low wage labor is no longer cheap labor and market forces cannot eliminate pay inequality due to labor market discrimination. This stands in sharp contrast to standard economic theory which suggests that labor market discrimination cannot explain the persistence of pay differentials between identifiable groups of individuals since such pay inequality would be eliminated by competitive market forces.