Wage Differentials Across Labor Markets and Workers : Does Cost of Living Matter?

Theory and evidence indicate that wage rates across labor markets adjust only partially with respect to differences in consumer prices. Earnings differentials are estimated for 185 labor markets during 1985-95, following control for worker and area characteristics, based on nominal wages, wages fully adjusted for price level, and an approximation of "real" wages with partial adjustment for price level. Dispersion in partial adjustment wages across markets, and differentials by region and city size, are substantially lower than dispersion in either nominal or full adjustment wages. Racial and ethnic differentials display moderate sensitivity to choice of a wage measure. Researchers should avoid full adjustment for area prices. Absent data on prices and amenities, one should include detailed controls for region and city size in nominal wage equations