Income Inequality and Aggregate Demand

Johanna Rude

MPRA Paper from University Library of Munich, Germany

Abstract: This paper investigates the relationship between income inequality and aggregate demand. It is shown empirically, that increases in income inequality are associated with decreased aggregate consumption. The analysis reveals a systematic difference in the relationship between income inequality and consumption expenditure across consumption categories In a theoretical analysis, the effect of an exogenous skill-biased technological change on equilibrium prices and expenditure shares is derived for the case of homothetic CES preferences and the case of non-homothetic CES preferences. In both cases, equilibrium prices and expenditure shares are affected via a supply-side channel. In the case of non-homothetic CES preferences, they are also affected via a demand-side channel, due to changes in income inequality. The comparison of model predictions under homothetic and non-homothetic preferences results in estimation equations that allow testing for non-homotheticity in consumption data. Empirical results indicate that preferences are indeed non-homothetic. Furthermore, the non-homothetic CES preferences are well suited to explain the distinct pattern observed between consumption categories and income inequality. In addition, a quantification of the novel demand-side channel is done to determine its direction and size. The results suggest, that the demand-side channel ameliorates exogenous changes in income inequality and is non-trivial in size.

Keywords: Income Inequality; Aggregate Demand; Non-homothetic Preferences (search for similar items in EconPapers)
JEL-codes: E20 E21 E25 E27 (search for similar items in EconPapers)
Date: 2024-05-07
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