Inequality and Capital

Markets - continued
February 7, 2024
How do you get credit?
• Whether or not the loan is forthcoming depends on the following
considerations
• How much wealth is available for collateral?
• How profitable will the business be?
• What kind of punishments are available in the event of default?
• The maximum size of the loan will be limited by these factors.
Occupational choice and the credit constraint
• The market might influence your economic outcomes by affecting the
ability to freely choose occupations or investments, and thereby the
evolution of inequality and output.
• Just three occupations:
• Subsistence producer,
• Industrial worker, and
• Entrepreneur
• Subsistence producers can produce some fixed amount z with their
labor.
• An industrial worker can earn a wage w.
• An entrepreneur runs the sort of business that hires industrial
workers, but the business requires startup capital, and this is where
the credit market comes in.
Will you honor your loan?
Implications
• If your wealth is lower than this critical level, you will be unable to
be an entrepreneur whether you want to be one or not.
• The smaller are the values of F (the expected cost of imprisonment)
and A (the fraction of your business profits that the bank can
appropriate), the more stringent is the requirement of initial wealth.
• If wages are relatively low, the profits from entrepreneurship are high,
and you would expect it to be easier to get a loan to go into business.
• Minimum wealth threshold required to obtain a loan should decline.
Wealth distributions and equilibrium

• Wealth typically is unequally distributed in the economy.

• It decides whether you become an entrepreneur or work in the
subsistence economy.
• These joint decisions then determine the wage rate in the economy at
that date.
• Higher the wage rate, the higher is the fraction of the population that
is shut out of entrepreneurship.
• The minimum wealth required for access to credit goes up.
• These individuals must then choose between subsistence and market
labor, and the choice depends on the wage rate.

• How the prevailing distribution of wealth feeds into the choice of

occupations and determines the shape of supply and demand curves,
and consequently the wage rate.
The supply curve of labor
The demand curve for labor
Determination of the equilibrium wage rate
The Inefficiency of Inequality
• What if a fraction of these individuals could have become entrepreneurs?
• Why doesn't the market permit these improvements to arise of their own
accord?
• Improvements require additional access to credit, and access is barred
because of the inequality in wealth.
• By hindering access to credit markets, it creates inefficiency in the
economy as a whole.
• High inequality gives rise to inefficient outcomes; it tends to replicate
itself, which prolongs the inefficiency (start-up costs, subsistence wages).
Inequality begets inequality
Lessons from the Model
• If capital markets were perfect, an individual's wealth would not
matter in obtaining the credit.
• Inequality has an effect on aggregate output. The greater the equality
in wealth distribution, the greater the degree of economic efficiency.
• There is no innate tendency for inequality to disappear over the long
run.
Two countries with exactly the same parameters of production and
preferences may nevertheless not converge with each other as far as
wealth distribution and output levels are concerned.
Research Essay

Inequality in India

Some of the questions

• What is the state of income inequality in India?
• What are the possible consequences of rise in income inequality?
• What can India do to reduce inequality?
Different perspectives
• Unequal recent growth
• Rising tide may not be lifting all boats
• Inequality might not be a problem at all
Rural wage rates
• Agricultural labour: Real wage rate has grown by 4.6 per cent over the
years from 204 to 2022-23.
• It peaks midway through the period and is stagnant thereafter.
• Non-agricultural labour: Lower
• 35 % of India’s workforce, real wage rate has not grown from 2014.
• Growth in economy, per capita income for the bottom of the pyramid
is not rising.
• 2014-23 real per capita income in India has increased by 37 %, while
real wage of agricultural labour has increased by less than 5 %.
Does it matter?
• Unequal societies are subjected to violence, mental health, disease.
• Gated communities, townships
• Collective action
• Swachh Bharat Mission
• Who wants a clean space and who are motivated to it?
• Inequality can defeat this attempts.
Format
• Introduction
• Define your research objective/question
• Methodology
• Findings/result
• Conclusion
• References
• 4000-5000 words
• Journal articles
• 2024 Asia-Pacific Human Development Report
• https://www.thehindu.com/opinion/lead/growth-mania-can-be-injuri
ous-to-society/article67790032.ece
• Oxfam report on inequality