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A central hypothesis about discrimination is that prejudice forces the stigmatized into low-paying, undesirable jobs. Prejudice clearly leads to exclusion. But surprisingly, evidence linking exclusion to disadvantage is mixed. We address this issue theoretically, providing a formal rational choice model combining arguments from sociology (on prejudice) and economics (on competition). Our theory suggests that economic organization is crucial. In economies dominated by monopoly, oligarchy, tradition, or government, prejudice may reduce some workers’ pay, and a disadvantageous secondary labor market may emerge. By contrast, in competitive free markets, exclusionary discrimination often occurs but does not reduce workers’ pay, nor does it induce a disadvantageous secondary labor market. Our theory suggests the conventional analytic approach to discrimination is misguided: Exclusion does not necessarily imply disadvantage; a shortfall in pay does not necessarily imply that the lower paid worker is disadvantaged; and analysis should focus on the overall subjective well-being or utility derived from a job, not on pay alone.