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Income Distribution in Macroeconomic Models

Income Distribution in Macroeconomic Models

Giuseppe Bertola
Reto Foellmi
Josef Zweimüller
Copyright Date: 2006
Pages: 456
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  • Book Info
    Income Distribution in Macroeconomic Models
    Book Description:

    This book looks at the distribution of income and wealth and the effects that this has on the macroeconomy, and vice versa. Is a more equal distribution of income beneficial or harmful for macroeconomic growth, and how does the distribution of wealth evolve in a market economy? Taking stock of results and methods developed in the context of the 1990s revival of growth theory, the authors focus on capital accumulation and long-run growth. They show how rigorous, optimization-based technical tools can be applied, beyond the representative-agent framework of analysis, to account for realistic market imperfections and for political-economic interactions.

    The treatment is thorough, yet accessible to students and nonspecialist economists, and it offers specialist readers a wide-ranging and innovative treatment of an increasingly important research field. The book follows a single analytical thread through a series of different growth models, allowing readers to appreciate their structure and crucial assumptions. This is particularly useful at a time when the literature on income distribution and growth has developed quickly and in several different directions, becoming difficult to overview.

    eISBN: 978-1-4008-6509-3
    Subjects: Economics

Table of Contents

  1. Front Matter
    (pp. i-iv)
  2. Table of Contents
    (pp. v-viii)
  3. Introduction
    (pp. ix-xviii)

    This book focuses on two main sets of issues. The first relates to the dynamics of aggregate variables when the population is heterogeneous. Under which conditions are the dynamics of capital accumulation affected by the distribution of income and wealth? When is a more equal distribution of income and wealth beneficial or harmful for accumulation and growth? The second set of issues refers to the dynamics of the distribution of income and/or wealth. How does the distribution of income and wealth evolve in a market economy? When does the gap between rich and poor people in market economy increase over...

  4. Part One Aggregate Growth and Individual Savings

    • CHAPTER ONE Production and Distribution of Income in a Market Economy
      (pp. 3-13)

      The aim of this book is to study the implications of economic interactions between heterogeneous individuals, both for macroeconomic outcomes and for the evolution of the income and wealth distribution. As these interactions are extremely complex, we organize our analysis around several key simplifications.

      First, we will assume throughout that there aretwo factors of production: an “accumulated” factor and a “non-accumulated” factor. We will frequently refer to the former as “capital” and to the latter as “labor.” As we discuss below, however, the important point is that the economy’s (as well as the households’) endowment with the former is...

    • CHAPTER TWO Exogenous Savings Propensities
      (pp. 14-27)

      In this chapter we focus on the evolution of inequality. Under neoclassical conditions, when each unit of a production factor is rewarded at the same rate, distributional dynamics are determined by savings choices. We proceed to study situations where macroeconomic variables influence the extent and evolution of inequality , but there isno feedback from distribution to macroeconomic developments. Even when relationships between macroeconomic aggregate variables do not depend on distribution, incomes and accumulated wealth may well be unequally distributed and the corresponding distributions may change over time.

      All models that help us to understand why rational agents are willing...

    • CHAPTER THREE Optimal Savings
      (pp. 28-50)

      We have seen in the last chapter that, when all consumers have the same constant marginal savings rate, the distribution of wealth will eventually converge toward the (exogenous) distribution of non-accumulated factors. When the marginal propensity to consume out of current income and wealth is constant and identical across households, wealthy people consume so much that, in steady state, all wealth differences—beyond those implied by non-accumulated factors—will eventually vanish. The ad hoc consumption functions considered earlier usefully highlight some important mechanic interactions between distribution and macroeconomic growth. It produces clear predictions about the dynamics of the distribution of...

    • CHAPTER FOUR Factor Income Distribution
      (pp. 51-87)

      The models outlined in the previous chapter studied the distribution of income, wealth, and consumption across individuals whose preferences were such as to avoid any direct relevance of distribution for the aggregate savings rate. In the “neoclassical” market economy we were considering, each individual is entitled to a portion of aggregate output on the basis off actor ownership, and each unit of every factor is compensated according to marginal productivity. In this chapter we relax the latter assumption, recognizing that imperfect market interactions, and taxes or subsidies, may well distort factor incomes away from the theoretical marginal productivity benchmark. We...

    • CHAPTER FIVE Savings and Distribution with Finite Horizons
      (pp. 88-126)

      In the previous chapter we have discussed the relationship between factor shares and long-run growth. In this chapter we focus more closely on the determinants of personal income and wealth distribution across individuals, beginning with a summary of previous chapters’ perspectives and of relevant empirical evidence.

      In chapter 3 we studied optimal savings choices when the economy’s households have an infinitely long time horizon and no additional households enter the economy. In that perfect world markets are complete, as all currently alive households can participate in perfect and integrated financial markets. Such a setup, together with the assumption of HARA...

    • CHAPTER SIX Factor Shares and Taxation in the OLG Model
      (pp. 127-144)

      In chapter 5 we have studied the dynamics of distribution when consumers have finite time horizons. In particular, we have explored the role of entrance of new households, of savings for old age (or falling labor incomes as consumers grow old), and of a bequest motive. Throughout this chapter we have assumed that factor rewards are determined on competitive markets. In such a neoclassical framework diminishing investment returns lead to a state of stagnation in the long run. Again, we have studied the case of HARA preferences to ensure aggregate neutrality of the endowment distribution. Just like in the models...

  5. Part Two Financial Market Imperfections

    • CHAPTER SEVEN Investment Opportunities and the Allocation of Savings
      (pp. 147-179)

      In all the models reviewed so far it was assumed that agents have access to fully integrated financial markets. By ruling out arbitrage, such markets offer the same rate of return to all individuals. In this chapter, we take the extreme opposite route and rule out access to financial markets altogether. Hence, investment must equal savings not only at the aggregate but also at theindividuallevel. This extreme assumption gives inequality a new and important role in determining aggregate phenomena. Since identical agents would not trade with each other even when allowed to do so, in the absence of...

    • CHAPTER EIGHT Risk and Financial Markets
      (pp. 180-203)

      In this and the following chapter we study how uncertainty affects the relationship between distribution and growth. In all previous chapters, the dynamics of individual and aggregate income, consumption, and wealth levels were deterministic. In reality, however, random shocks are clearly relevant, both to the evolution of aggregate resources and to the evolution of their distribution. There are several reason why this is the case. First, random shocks imply there are winners and losers. In other words, luck and misfortune per se (in addition to initial conditions and individual choices) become a source of inequality. Second, depending on how resources...

    • CHAPTER NINE Uninsurable Income Shocks
      (pp. 204-238)

      As we discussed at the end of the previous chapter, the need to elicit effort limits the scope for risk sharing in investment projects. Moral hazard problems are perhaps even more important for (non-accumulated) labor income; so, it is difficult to obtain insurance against bad luck in the labor market. Bad luck is obviously possible in the form of involuntary unemployment, yet unemployment insurance is hardly provided by private companies—and public unemployment insurance schemes face challenging efficiency problems, also due to imperfect information, which we review briefly in the concluding section of this chapter. There we also discuss the...

  6. Part Three Many Goods

    • CHAPTER TEN Distribution and Market Power
      (pp. 241-265)

      In parts 1 and 2 of this book we have focused on the role of savings behavior and/or financial market imperfections to understand potentially important channels which link an economy’s growth rate to the distribution of income and wealth, and vice versa. Throughout parts 1 and 2, we made the simplifying assumption that the economy’s output consists of a single good. In the last part of this book we relax this assumption and allow for multiple commodities.

      The assumption of a single output good allowed us to focus on various potentially important channels that link income distribution to growth without...

    • CHAPTER ELEVEN Indivisible Goods and the Composition of Demand
      (pp. 266-301)

      In the models studied in chapter 10, households earned unequal incomes and consumed unequal amounts of each product, but each household allocated the same expenditure share to each product. In other words, while there are differences in the consumed quantities,the structure of consumptiondoes not differ across consumers,and the composition of aggregate demand is unaffected by the income distribution. The assumption of infinitely high marginal utilities for the first units of a particular good prevented consumers from concentrating their expenditure on a subset of the supplied commodities. This is clearly an unrealistic feature of these models. In reality,...

    • CHAPTER TWELVE Hierarchic Preferences
      (pp. 302-320)

      So far, we have assumed that the various goods enter the utility function in a symmetric way. This assumption, which implies that all goods have the same priority in consumption, does not correspond well with actual consumer behavior. In reality, the different goods have different priorities and the consumption of a new good is considered only if the more urgent wants are already satisfied. In this chapter we focus on models that allow us to account for such hierarchic preferences. In particular we study the implications of income distribution for growth and patterns of structural change when consumers have hierarchic...

    • CHAPTER THIRTEEN Dynamic Interactions of Demand and Supply
      (pp. 321-338)

      So far, all multiple goods models studied have focused on the interaction of income distribution and consumer demand. In chapter 10 we have studied models where income distribution has an impact on prices and mark-ups because the nature of individual demand curves may change with the level of income. In chapter 11 our focus was on models where income distribution had an effect on market size as indivisibilities in consumption generated outcomes in which poor consumers could not afford all the goods supplied on the market. In chapter 12 we developed a general framework that allowed us to generate situations...

  7. Solutions to Exercises
    (pp. 339-398)
  8. References
    (pp. 399-418)
  9. Index
    (pp. 419-421)