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Income Inequality and Aggregate Demand

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  • Rude, Johanna

Abstract

This paper investigates the relationship between income inequality and aggregate demand. It is shown empirically, that increases in income inequality are associated with decreased aggregate consumption. The analysis reveals a systematic difference in the relationship between income inequality and consumption expenditure across consumption categories In a theoretical analysis, the effect of an exogenous skill-biased technological change on equilibrium prices and expenditure shares is derived for the case of homothetic CES preferences and the case of non-homothetic CES preferences. In both cases, equilibrium prices and expenditure shares are affected via a supply-side channel. In the case of non-homothetic CES preferences, they are also affected via a demand-side channel, due to changes in income inequality. The comparison of model predictions under homothetic and non-homothetic preferences results in estimation equations that allow testing for non-homotheticity in consumption data. Empirical results indicate that preferences are indeed non-homothetic. Furthermore, the non-homothetic CES preferences are well suited to explain the distinct pattern observed between consumption categories and income inequality. In addition, a quantification of the novel demand-side channel is done to determine its direction and size. The results suggest, that the demand-side channel ameliorates exogenous changes in income inequality and is non-trivial in size.

Suggested Citation

  • Rude, Johanna, 2024. "Income Inequality and Aggregate Demand," MPRA Paper 120875, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:120875
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    References listed on IDEAS

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    Keywords

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    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E25 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Aggregate Factor Income Distribution
    • E27 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Forecasting and Simulation: Models and Applications

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