Non-Homothetic Preferences and Labor Heterogeneity: The Effects of Income Inequality on Trade Patterns
This paper builds a two-country-two-sector trade model with a monopolistically competitive sector and non-homothetic preferences. It assumes the existence of two types of goods: necessities (which are homogeneous) and luxuries (which are differentiated) and heterogeneous labor. The implications of income inequality on trade patterns are examined. It also considers the effects of redistributive policies on the production structure and welfare of countries and concludes that: First, in autarky, the more unequal country produces a larger number of varieties; Second, the opening to trade will unambiguously increase the number of varieties consumed by any country, and hence, welfare; Third, the more equal country benefits more from trade liberalization. Fourth, a redistributive policy may harm some consumers not only by diminishing disposable income, but also by diminishing the number of varieties produced.
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