The effect of better information on income inequality

Bernhard Eckwert, Itzhak Zilcha

Research output: Contribution to journalArticlepeer-review

Abstract

We consider an OLG economy with endogenous investment in human capital. Heterogeneity in individual human capital levels is modelled by a distribution of innate ability across agents. This distribution is common knowledge but, at young age, no agent knows his/her ability. The production of human capital depends on each individual's investment in education. This investment decision is taken only after observing a signal which is correlated to his/her true ability, and which is used for updating beliefs. Thus, a better information system affects the distribution of human capital in each generation. Assuming separable and identical preferences for all individuals, we derive the following results in equilibrium: (a) If the relative measure of risk aversion is less (more) than 1 then more information raises (reduces) income inequality. (b) When a risk sharing market is available better information results in higher inequality regardless of the measure risk aversion.

Original languageEnglish
Pages (from-to)287-307
Number of pages21
JournalEconomic Theory
Volume32
Issue number2
DOIs
StatePublished - Aug 2007

Keywords

  • Income inequality
  • Information system
  • Risk sharing markets

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