Abstract

The paper focuses on an employee’s perception of his or her own labour market outcome. It proposes that the basic earnings function, by adopting an approach that ignores perception effects, is likely to result in biased results that will fail to understand the complexities of the wage distribution. The paper uses an orthodox job search framework to illustrate the nature of this problem and then adapts the model to take onboard the theory of cognitive dissonance. The search model indicates how workers may adopt a coping strategy in order to reduce the disutility associated with the wage underpayment that develops. Then, by modelling cognitive dissonance, the paper highlights the weaknesses of using purely human capital proxies to understand labour market outcome. The analysis goes some way to explaining why individuals with equivalent human capital investment can have disparate earnings profiles