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Mass versus Exclusive Goods, and Formal-Sector Employment

  • Reto Foellmi
  • Josef Zweimüller

We explore how the underemployment problem of less-developed economies is related to income inequality. Our crucial assumption is that consumers have non-homothetic preferences over differentiated products of formal-sector goods and thus that inequality affects the composition of aggregate demand via the price-setting behavior of formal-sector firms. We find that (i) high inequality divides the formal sector into mass producers (which charge low prices that are within the reach of the poor) and exclusive producers (which charge high prices and sell only to the rich); (ii) high inequality generates an equilibrium where many workers are crowded into the informal economy; and (iii) an increase in subsistence productivity raises the wages of unskilled workers and boosts employment due to the higher purchasing power of poorer households.

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Paper provided by Universitaet Bern, Departement Volkswirtschaft in its series Diskussionsschriften with number dp1005.

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Date of creation: Feb 2010
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Handle: RePEc:ube:dpvwib:dp1005
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  1. Falkinger, Josef, 1994. "An Engelian model of growth and innovation with hierarchic consumer demand and unequal incomes," Ricerche Economiche, Elsevier, vol. 48(2), pages 123-139, June.
  2. Chong, Alberto & Gradstein, Mark, 2007. "Inequality and informality," Journal of Public Economics, Elsevier, vol. 91(1-2), pages 159-179, February.
  3. Devashish Mitra & Vitor Trindade, 2005. "Inequality and trade," Canadian Journal of Economics, Canadian Economics Association, vol. 38(4), pages 1253-1271, November.
  4. Diego Winkelried, 2005. "Income Distribution and the Size of the Informal Sector," Development and Comp Systems 0512005, EconWPA.
  5. Silvestre, J., 1991. "The Market-Power Foundations of Macroeconomic Policy," Papers 374, California Davis - Institute of Governmental Affairs.
  6. Reto Foellmi & Josef Zweimüller, . "Income Distribution and Demand-induced Innovations," IEW - Working Papers 212, Institute for Empirical Research in Economics - University of Zurich.
  7. Foellmi, Reto & Oechslin, Manuel, 2007. "Who gains from non-collusive corruption?," Journal of Development Economics, Elsevier, vol. 82(1), pages 95-119, January.
  8. d’ASPREMONT, C. & DOS SANTOS FERREIRA, R. & GERARD-VARET, L.-A., 1986. "On monopolistic competition and involuntary unemployment," CORE Discussion Papers 1986035, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  9. Silvestre, J., 1988. "There May Be Unemployment When The Labor Market Is Competitive And The Output Market Is Not," Papers 316, California Davis - Institute of Governmental Affairs.
  10. Oded Galor & Omer Moav, 2004. "From Physical to Human Capital Accumulation: Inequality and the Process of Development," GE, Growth, Math methods 0410005, EconWPA.
  11. Dehez, Pierre, 1985. "Monopolistic equilibrium and involuntary unemployment," Journal of Economic Theory, Elsevier, vol. 36(1), pages 160-165, June.
  12. Chol-Won Li., . "Inequality and Growth: A Schumpeterian Perspective," Working Papers 9609, Business School - Economics, University of Glasgow, revised Feb 1998.
  13. Flam, Harry & Helpman, Elhanan, 1987. "Vertical Product Differentiation and North-South Trade," American Economic Review, American Economic Association, vol. 77(5), pages 810-22, December.
  14. Sleuwaegen, Leo & Goedhuys, Micheline, 2002. "Growth of firms in developing countries, evidence from Cote d'Ivoire," Journal of Development Economics, Elsevier, vol. 68(1), pages 117-135, June.
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