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Neoclassical production, scarcity of skills and Pareto distributions

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  • Lopez-Velasco, Armando R.

Abstract

The distribution of top earnings follows a “power-law”: the top tail of the distribution is thick relative to other distributions and is approximately Pareto-distributed. There are different mechanisms proposed in the literature that yield Pareto distributions and power-laws. This paper shows that a simple general equilibrium model where aggregate production is assumed of the constant-elasticity-of-substitution (CES) type over multiple labor inputs generates distributions in earnings and wages that follow power-laws. The finding is very general as the distribution of the skill-types is irrelevant for the shape parameter (the Pareto exponent) of the power-law. The model displays a tight relationship between the Pareto exponent and the elasticity of substitution between the labor inputs. Available empirical estimates of the elasticities of labor substitution and of the labor supply predict a Pareto exponent consistent with its empirical counterpart for the distribution of earnings in the US.

Suggested Citation

  • Lopez-Velasco, Armando R., 2024. "Neoclassical production, scarcity of skills and Pareto distributions," Economics Letters, Elsevier, vol. 234(C).
    • Handle: RePEc:eee:ecolet:v:234:y:2024:i:c:s0165176523005219
    DOI: 10.1016/j.econlet.2023.111495
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    More about this item

    Keywords

    Power law; Pareto; CES; Earnings distribution; Income distribution; Wage distribution;
    All these keywords.

    JEL classification:

    • D2 - Microeconomics - - Production and Organizations
    • D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
    • D33 - Microeconomics - - Distribution - - - Factor Income Distribution
    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials

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