Using directed search to model the product market and the labor market, I show that large plants can pay higher wages to homogeneous workers and earn higher expected profit per worker than small plants, although plants are identical except size. A large plant charges a higher price for its product and compensates buyers with a higher service probability. To capture this size- related benefit, large plants try to become larger by recruiting at high wages. This size-wage differential survives labor market competition because a high wage is harder to get than a low wage. Moreover, the size-wage differential increases with the product demand when demand is initially low and falls when demand is already high. Copyright 2002 by the Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Resarch Association
