This paper formalizes the use of flexible labour contracts in an efficiency wage framework, and derives market dualism as an endogenous outcome. By allowing temporary contracts to be either renewed or converted into permanent contracts, we obtain new theoretical insights into the market equilibrium. The conversion rate is itself an incentive device that acts as a substitute for the wage, and firms pay a wage differential in favour of permanent workers. The model also predicts that even if firms hire exclusively under flexible contracts, dualism arises as a feature internal to each firm and, consequently, as a market property.
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