Economies are studied where labor contracts, even without changing real allocations, can make equilibria appear different. One basic example is that wage observations generated by long-term employment contracts are biased measures of theoretical market wages. This idea is analyzed in a dynamic, stochastic, economic model, including both overlapping generations of finite-lived workers and infinite-horizon employers, so that the implications for business cycle, life cycle, and cross-sectional phenomena can be explicitly addressed. Understanding contracts in this way potentially allows us to reconcile several ostensibly anomalous aspects of the data with equilibrium theory.

This article investigates racial differences in 1985-86 salaries of individual professional basketball players. White and black players earn similar mean compensation; however, controlling for a variety of productivity and market-related variables and for the endogeneity of player draft position, we find a significant ceteris paribus black compensation shortfall of about 20%. Further, we find that all else equal, including team performance and market factors, replacing one black player with an identical white player raises home attendance by 8,000 to 13,000 fans per season. The compensation and attendance results together are consistent with the idea of customer discrimination.