INSIDER POWER, WAGE DISCRIMINATION AND FAIRNESS

The exercise of insider power is frequently considered as a major cause of involuntary unemployment. We show that under standard assumptions - insiders are selfish and they need not fear the loss of their job - insider power does not cause unemployment but leads to the introduction of a market clearing two-tier wage system. Yet, while insider power is a common phenomenon two-tier systems are rarely observed. To explain this fact we introduce interdependent preferences. We show that if entrants exhibit a preference for fairness the presence of insider power gives rise to an efficiency wage effect which may prevent the introduction of market clearing two-tier systems.