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Income inequality, neighbourhood effects and product quality

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  • Namrata Gulati

    ()
    (Indian Statistical Institute, New Delhi)

  • Prabal Roy Chowdhury

    ()
    (Indian Statistical Institute, New Delhi)

Abstract

In this paper we analyze the effect of income inequality on market outcome and hence the welfare of the consumer in the industry which is both horizontally and vertically differentiated. The idea is that any income distribution over the spatial horizon is reflected in the demand structure and this shapes the market outcome. We consider a setting where the rich and poor live side by side on a linear city and two duopolist firms are positioned at the two ends of the city. We find that for a homogenous distribution of income or when the poor's income or density is too low, both firms offer the same quality. For a homogenous income distribution firm does not perceive much benefit from product differentiation. Given this, for a very high difference in the fixed costs, both firms offer the low quality. But when the difference in the fixed costs is low, both firms offer the high quality. For a more heterogeneous income distribution and an intermediate range of the difference in fixed costs, one firm offers the high quality and the other the low quality. Product differentiation on one hand allows firm to alleviate price competition and, on the other hand, serves consumers' demand better. We show that although in general a rise in income inequality has a spiraling negative effect on the welfare of the poor, there are situations, particularly when the poor income is very low, when an increase in the rich income could be welfare improving for the poor.

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Bibliographic Info

Paper provided by Indian Statistical Institute, New Delhi, India in its series Indian Statistical Institute, Planning Unit, New Delhi Discussion Papers with number 10-06.

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Length: 50 pages
Date of creation: Aug 2010
Date of revision:
Handle: RePEc:ind:isipdp:10-06

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  1. Neven, D. & Thisse, J-F., 1989. "On Quality And Variety Competition," CORE Discussion Papers 1989020, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  2. Pablo Fajgelbaum & Gene M. Grossman & Elhanan Helpman, 2011. "Income Distribution, Product Quality, and International Trade," Journal of Political Economy, University of Chicago Press, vol. 119(4), pages 721 - 765.
  3. Olivier Coibion & Liran Einav & Juan Carlos Hallak, 2006. "Equilibrium Demand Elasticities across Quality Segments," Working Papers 550, Research Seminar in International Economics, University of Michigan.
  4. Wauthy, Xavier, 1996. "Quality Choice in Models of Vertical Differentiation," Journal of Industrial Economics, Wiley Blackwell, vol. 44(3), pages 345-53, September.
  5. Tarasov, Alexander, 2007. "Income Distribution, Market Structure, and Individual Welfare," MPRA Paper 7682, University Library of Munich, Germany, revised Jan 2008.
  6. Yurko, Anna, 2006. "How Does Income Inequality Affect Market Outcomes in Vertically Differentiated Markets?," MPRA Paper 4028, University Library of Munich, Germany, revised Jul 2007.
  7. Corrado Benassi & Alessandra Chirco & Caterina Colombo, 2006. "Vertical Differentiation And The Distribution Of Income," Bulletin of Economic Research, Wiley Blackwell, vol. 58(4), pages 345-367, October.
  8. Jyotsna Jalan & E.Somanathan, 2004. "Being informed matters: Experimental evidence on the demand for environmental quality," Indian Statistical Institute, Planning Unit, New Delhi Discussion Papers 04-08, Indian Statistical Institute, New Delhi, India.
  9. Jaskold Gabszewicz, J. & Thisse, J. -F., 1979. "Price competition, quality and income disparities," Journal of Economic Theory, Elsevier, vol. 20(3), pages 340-359, June.
  10. Mas-Colell, Andreu & Whinston, Michael D. & Green, Jerry R., 1995. "Microeconomic Theory," OUP Catalogue, Oxford University Press, number 9780195102680.
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