How To Spend It

Have you ever read that FT supplement and wondered how and why the mix of products is changing with increasing income inequality?  Anna Yurko tackles this question:

The
distribution of consumer incomes is a key factor in determining the structure
of a vertically differentiated industry when consumer’s willingness to pay
depends on his income. This paper computes the Shaked and Sutton (1982) model
for a general specification of consumers’ income distribution to investigate
the effect of inequality on firms’ entry, product quality, and pricing
decisions. The main findings are that greater inequality in consumer incomes
leads to the entry of more firms and results in more intense quality competition
among the entrants. This is due to the elasticity of consumer demand for
quality being higher in more inegalitarian economies. More intense quality
competition among firms causes them to locate their products in higher ranges
of the quality spectrum, closer to each other, decreasing the degree of product
differentiation. Competition between more similar products tends to reduce
their prices. However, when income inequality is very high, the top quality
producer chooses to serve only the rich segment of the market, and the low
price elasticity of demand of these consumers allows him to charge a higher
price. The conclusion is that income inequality has important implications for
the degree of product differentiation, price level, industry concentration, and
consumer welfare.

My version of the argument is this: growing income inequality means greater elasticity of demand, thus causing quality competition to displace price competition for some market segments.  More concretely, there is often more profit from serving the very top, who will always pay more for something just a wee bit different or a wee bit better.  So stay away from producing the mid-level cheeseburger, where price elasticity of demand will kill your profits.  You can’t charge the rich very much for it, and the presence of the poor keeps the price down for the middle class.  Here is the paper.  Anna is currently a job market candidate at the University of Texas, here is her CV.