Non-homothetic preferences and growth

Abstract

We observe that countries at low levels of income invest at lower rates than those at higher levels of income. This paper explains this fact as a consequence of Engel's law, i.e. that there is an inverse relation between expenditure and its proportion spent on food. It introduces non-homothetic preferences based on Engel’s law in a simple Solow model. These preferences imply rates of net investment that increase with the level of income as we approach the steady state. Increasing investment rates imply a positive correlation between growth rates and the level of income, at low levels of income, rather than an inverse relation, as the usual Solow model implies. The existence of a positive correlation between income growth rates and income levels, at low levels of income in the presence of this type of preference, has already been shown in a previous paper for a closed economy. The purpose of this paper is to show that this positive correlation persists when we introduce trade into the model.

Keywords:

• Engel's Law
• Growth
• Investment Rates