Wage and Price Dispersion: On-the-job-search meets Monopolistic Competition

I extend a simple model with on-the-job-search in the labor market by monopolistic competition in the goods market. It is well known that the simple on-the-job-search model predicts a wage distribution which is convex where empirical evidence suggests that it is humpshaped. My model is able to predict a hump-shaped wage distribution. The intuition for the decline of the density function at the top wages is straightforward. In equilibrium high-price-firms will be the ones to pay high wages, however these firms cannot be large in number since the high-price output will not be sold in large quantities in equilibrium. Finally, the fact that both wages and prices are endogenous to the model allows interesting policy experiments. I study the quantitative effect on employment, output, price and wage dispersion after a change in the reservation wage and after an increase in the job offer arrival rate λ.