Understanding the City Size

In 2000, wages of full time full year workers were over 30 percent higher in metropolitan areas of over 1.5 million people than rural areas. The monotonic relationship between wages and city size is robust to controls for age, schooling and labor market experience. In this paper, we decompose the city size wage gap into various components. We propose a labor market search model that incorporates endogenous migration between large, medium and small cities. This model is sufficiently rich to allow for recovery of the underlying ability distributions of workers by city size, arrival rates of job offers by ability and location, and returns to experience by ability and location, when structurally estimated using longitudinal data. Estimates from the structural model facilitate a more complete empirical decomposition of the city size wage gap than is possible using results in existing research. Counterfactual simulations of the model indicate that variation in the return to experience across location type is the most important mechanism contributing to the overall city size wage premium. Differences in wage intercepts across location type generate an important part of the medium sized city premium for high school graduates. Finally, sorting on unobserved ability within education group and differences in labor market search frictions contribute slightly negatively if at all to observed city size wage premia. Wisconsin. We thank Emek Basker for generously providing us with ACCRA price index data.