Skilled-unskilled wage inequality, product variety and unemployment: A static general equilibrium analysis

The paper develops a three-sector small open economy model with two traded final good sectors and a nontraded good sector producing varieties of intermediate goods. There are three primary factors: capital, skilled labour and unskilled labour. Industrial sector producing a tradedgood uses capital, intermediate goods and skilled labour as inputs. Intermediate goods producing sector also uses capital and skilled labour. The efficiency wage hypothesis is introduced to explain unemployment in each of these two labour markets. It is shown that an increase in either type of labour endowment (capital endowment) raises (lowers) the unemployment rate of either type of labour if the scale elasticity of output is very low. On the other hand, if the industrial sector is more capital intensive than the agricultural sector and if efficiency functions of both types of labour are identical, then an increase in either type of labour endowment (capital endowment) lowers(raises) the skilled-unskilled wage ratio. However, the effect of a change in capital endowment on the Gini Coefficient of wage income distribution is ambiguous in sign.