A Consumption Model of Income Inequality

Walter J. Wessels

Abstract


This article focuses on the inequality of incomes between the very
rich and the rest of society. Accordingly, it measures inequality as the
ratio of the share of national income of the top five percent of households
over the share of the rest of society. It shows that this measure
of inequality increases when productivity grows in the manufacturing
sector and decreases when productivity grows in the nonmanufacturing
sector. These results suggest the rich earn relatively more when productivity
lags in the nonmanufacturing sector. A model is presented
that provides an explanation for these results. With complete markets,
risk-averse individuals will hold a portfolio of assets that effectively
produces the goods they intend to consume in order to insure they get
the consumption mix they want. Since the rich spend relatively more
on superior goods, they will hold relatively more assets in the superior
good sector. When productivity grows in the necessity sector, the relative
price of superior goods increases and the rich, holding relatively
more of the assets producing superior goods, will become richer. The
opposite occurs when productivity grows in the superior-good sector.
Evidence suggests that nonmanufactured goods are superior goods.

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