Co-author(s): Andrii Parkhomenko, Jorge de la Roca
Abstract: We use individual geocoded data from Peru and document that the city-size wage premium is larger for low-skilled than for high-skilled workers, in contrast with most developed countries. We interpret this evidence using a model of location choice with private amenity goods and non-homothetic preferences. Skilled workers enjoy higher incomes and devote a higher expenditure share to amenity goods, such as private schools or middle-class neighborhoods. The supply of these amenities is subject to a fixed cost, and only sufficiently large cities have enough demand to offer them. Thus, skilled workers demand a higher wage premium to live in small cities, and the returns to working in a large city are smaller for them than for their unskilled counterparts. Our quantitative exercises indicate that the mechanism accounts for two-thirds of the gap in the city-size wage premium between high- and low-skilled workers.