Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/76755
Authors: 
Foellmi, Reto
Zweimüller, Josef
Year of Publication: 
2010
Series/Report no.: 
Discussion Papers, Department of Economics, Universität Bern 10-05
Abstract: 
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.
Subjects: 
income distribution
monopolistic competition
mark-ups
exclusion
JEL: 
E25
D30
D42
L16
E24
Document Type: 
Working Paper

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