We analyze some macroeconomic implications that follow from the fact that people tend to consume higher-quality goods as their incomes rise. The model involves two sectors: one producing a homogeneous good and the other producing a product with variable levels of quality. Both sectors use skilled and unskilled labour, but higher quality varieties of the differentiated good are more skilled-labour intensive. The skilled-tounskilled wage ratio is fixed at a level sufficiently low that some unskilled workersremain unemployed. We show that uniform (across sectors), Hicks-neutral technological progress must increase the unemployment rate. We then discuss a number of policy responses (tax cuts, direct government employment of the unskilled, employment subsidies to firms for hiring the unskilled, increased generosity of unemployment insurance) under different scenarios concerning how the government finances these initiatives. Political economy consequences are emphasized, as we assess each policy's chance of receiving political support from skilled workers. We conclude that a subsidy for the employment of unskilled workers, financed by a rise in the employer payroll tax rate associated with skilled workers is a viable policy option.
technical change vertical product differentiation unemployment income distribution.