Pareto Distributions in Economic Growth Models
This paper analytically demonstrates that the tails of income and wealth distributions converge to a Pareto distribution in a variation of the Solow or Ramsey growth model where households bear idiosyncratic investment shocks. The Pareto exponent is shown to be decreasing in the shock variance, increasing in the growth rate, and increased by redistribution policies by income or bequest tax. Simulations show that even in the short run the exponent is affected by those fundamentals. We argue that the Pareto exponent is determined by the balance between the savings from labor income and the asset income contributed by risk-taking behavior.
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