Memorandum, Department of Economics, University of Oslo 2000,35
We study an economy where a required amount of household production can be carried out either by each household itself, or purchased in the regular or ”black” market. We assume that the economy has two types of individuals, one with low productivities, and another with high productivities and a comparative advantage in the industrial (non-service) sector. We show for a ”moderate” rate of taxation, that lowproductivity workers tend to produce their own home services, while high-productivity workers purchase these in the regular market, given that a black market does not exist. The introduction of a black market is then socially gainful whenever black-market services are demanded by low-productivity workers, and socially harmful whenever such services are demanded by high-productivity workers. We find that when the tax rate is either in an intermediate range, or is very high, the black market leads to allocation gains, while the black market leads to allocation losses when the tax rate is in between these ranges.