Inequality and Research Incentives.pdf - Inequality and Research Incentives 4.1 Introduction In this chapter we study the impact of inequahty on the

Inequality and Research Incentives.pdf - Inequality and...

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Inequality and Research Incentives 4.1 Introduction In this chapter we study the impact of inequahty on the incentives to innovate. Recall that the structure of demand is affected by the distribution of income when consumers have hierarchic preferences. Poor people concentrate most of their expenditures on basic needs, whereas richer people direct their expenditures to more luxurious goods. The empirical relevance of a hierarchic structure of demand is documented by 'Engel's law', one of the most robust empirical findings in economics. In the standard Schumpeterian growth models consumers have homothetic pref- erences. By this assumption, the level of demand for the various goods - including the innovator's product - does not depend on the income distribution. Instead, we study a situation where preferences are non-homothetic and income distribution has an impact, both on the composition of consumer demand and on the struc- ture of prices that innovators charge for their product. This yields a rich set-up that allows us to study the inequality growth-nexus via a channel that has not attracted much attention in the recent literature. When product demand is affected by the income distribution, inequality be- comes a determinant of economic growth. The demand-channel has received little
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76 4. Inequality and Research Incentives attention in the inequahty-growth Hterature.-^ Instead, much of the recent Uter- ature has either focused on the role of capital market imperfections, (see Galor and Zeira (1993), Banerjee and Newman (1993), Aghion and Bolton (1997), and others) or on political mechanisms (Bertola (1993), Persson and Tabellini (1994), Alesina and Rodrik (1994), and others). In contrast, this chapter focuses on the role of inequality for the dynamics of an innovator's demand and does neither rely on imperfect capital markets nor on politico-economic arguments. In this chapter, we introduce hierarchic preferences in the simplest possible way. In order to satisfy a certain want, consumers buy one unit of an indivisible good, i.e. the sub utility function v{-) takes the form of 0-1-preferences. The hierarchy implies that poor consumers will only buy a small range of high priority goods, whereas richer people will consume a wider range including also goods of lower priority. Hence, the incentive to conduct R&D is affected by the distribution of income as inequality determines the level of demand and the optimal price of an innovator. Today, the good of an innovator may be purchased only by a small group of rich people and the willingness to pay for this product will initially be low. But as incomes grow the size of the market grows as also less wealthy people become willing to buy. One novel aspect of our approach is to study how income distribution affects the time path of demand for the innovator's good; the other novel aspect is that the prices and mark-ups of innovators are determined by the distribution. This means we can study a situation where both depend on the income distribution and both affect the reward to an innovation. We therefore
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