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Can a rise in income inequality improve welfare?

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Author Info
Pérez Truglia, Ricardo Nicolás

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Abstract

While in homogenous societies income can only buy traditional goods (e.g. food, clothes), this paper claims that in heterogeneous societies income can also buy non-market goods (e.g. respect, friends). Such transactions take place through the signaling of unobservable characteristics via conspicuous consumption. The theoretical model shows that: i. Conspicuous consumption is an efficient allocation mechanism for some non-market goods; ii. There is an efficiency loss associated to a progressive redistribution of incomes; iii. The loss is particularly important in more "meritocratic" societies. Then I test my conjectures based on panel data on life satisfaction for 10,000 respondents in Russia for 2000-2002, exploiting two identification strategies. The following results emerge: i. Expenditure inequality within reference groups does increase the marginal utility derived from consumption; ii. The "direct" distaste for inequality has been considerably underestimated by the literature; iii. The model provides a micro-foundation for the idea of a utility function first concave and then convex. The results remain unchanged after controlling for the income equivalence scale elasticity and a wide range of recent economic theories on life satisfaction.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 4700.

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Date of creation: 29 Jan 2007
Date of revision: 22 Dec 2007
Handle: RePEc:pra:mprapa:4700

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Related research
Keywords: Happiness; well being; life satisfaction; income; expenditures; conspicuous consumption; inequality; welfare; signaling; Friedman-Savage; income equivalence scale elasticity; comparison income; reference group; non-market goods and services.;

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Find related papers by JEL classification:
C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data
D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis

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