The effect of technological change on wage differentials between skilled and unskilled labour has been extensively investigated. However, the existing literature provides controversial results. This paper provides insights into the relationship between technological change and wage differentials by constructing a DIGE models of a closed economy. This model suggests a range of policy implications.

The main results are: first, technology upgrade increases wage differentials by a larger percentage than the size of the shock in the short run and reduces wage differentials in the long run. Second, government would expect an increasing short-run and a decreasing long-run wage differential if it increases the tax rate. Third, the effect of increased education investment on wage differentials is unambiguous in the short run. However, in the long run wage differentials decrease.