Preference shifts and wage inequality

Abstract

This paper analyzes how preference shifts affect wage inequality. We take the Cobb–Douglas preference, the Dixit-Stiglitz preference and the quasi-linear preference into account, and find that there exists preference-driven wage inequality. In the two-type labor (i.e. skilled labor and unskilled labor) models, when the preferences of consumers for skilled products are strengthened, wage inequality will be widened (resp. narrowed down) if there is a relatively low (resp. high) capital intensity in the unskilled sector. We also build a three-type labor (i.e. high-skilled labor, medium-skilled labor, and unskilled labor) model and a model with a non-tradable unskilled sector to strengthen the explanatory power. The role of preferences shifts in changing wage inequality is overlooked by the existing literature.

KEYWORDS:

• Wage inequality
• preference shift
• Cobb–Douglas preference
• Dixit-Stiglitz preference
• quasi-linear preference

JEL Classifications:

• J31
• L13

Disclosure statement

No potential conflict of interest was reported by the author(s).

Correction Statement

This article has been republished with minor changes. These changes do not impact the academic content of the article.

Notes

1 As we know, in Propositions 2.1, 3.1, 3.2, the wage rates and wage inequality remain unchanged in this case.

2 It can be verified by analyzing equations (5) and (24).

3 In the case of the quasi-linear utility function, we have known that the budget share of skilled products is increasing in $\alpha$. Considering the elasticity of the budget share with respect to $\alpha$ at equilibrium, the result is similar to the case of the Dixit-Stiglitz utility function.

4 Medium-skilled labor is only used as the fixed input, but high-skilled labor is utilized as the fixed input and the variable input. The free-entry condition implies that the ratio of the fixed cost to the variable cost equals ${\sigma }^{-1}/(1-{\sigma }^{-1})$. When the demand elasticity increases (resp., decreases), the fixed cost increases more slowly (resp., quickly) than the variable cost and there will be an increase (resp., a decrease) in wage inequality between medium-skilled labor and high-skilled labor.

5 Our method here is similar to that of Beladi and Chao (2006).