Working Paper: CEPR ID: DP5824
Authors: Reto Foellmi; Josef Zweimüller
Abstract: We introduce non-homothetic preferences into a general equilibrium model of monopolistic competition and explore the impact of income inequality on the medium-run macroeconomic equilibrium. We find that (i) a sufficiently high extent of inequality divides the economy into mass consumption sectors (where firms charge low prices and hire many workers) and exclusive sectors (where firms charge high prices and hire few workers). (ii) High inequality may lead to a situation of underemployment and that underemployment could be "Keynesian" in the sense that it cannot be cured by downward-flexible real wages. (iii) A redistribution of income from rich to poor (by means of progressive taxation) leads to higher employment and such a redistribution is Pareto-improving. (iv) An exogenous increase in (minimum) real wages have a cost effect (that lets firms reduce their employment) and a purchasing power effect (that creates an incentive for mass production and raises aggregate employment) with ambiguous net effects. (v) The economy may feature multiple equilibria where full-employment and unemployment equilibria co-exist.
Keywords: Exclusion; Income Distribution; Markups; Monopolistic Competition
JEL Codes: D30; D42; E24; E25; L16
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| high extent of income inequality (D31) | division of the economy into mass consumption sectors and exclusive sectors (E20) |
| high extent of income inequality (D31) | lower aggregate demand for labor (J23) |
| high extent of income inequality (D31) | underemployment (J64) |
| income redistribution through progressive taxation (H23) | higher employment (J68) |
| increase in minimum real wages (J38) | ambiguous net effects on employment (J68) |
| income inequality (D31) | complex and non-linear relationship with employment (J29) |