An Empirical Test of the Institutionalist View on Income Inequality

CLARENCE C. MORRISON [*] ABSTRACT. Using a general equilibrium model that is completely free of macroeconomic aggregates, this paper addresses some questions that are central to macroeconomics. Keynes' underemployment equilibrium is replicated, but it is illustrated that this result rests on the assumption that stockholders are so pessimistic that they save (hoard) all unanticipated dividends for a rainy day. If stockholders spend their unanticipated dividends in the next time period it is illustrated that unemployment will converge to zero over time. This process can be speeded by wage adjustments but will occur with or without wage flexibility. In addition, some fairly plausible scenarios involving overfull employment and inflation are presented. Finally, it is illustrated that if the producers in the model attempt to maneuver labor shortages to their advantage, they may be met with unanticipated results. I Introduction MICROFOUNDATIONS IS THE NAME that has been given to theoretical efforts to reconcile microeconmics and macroeconomics. In 1979 E. Roy Weintraub surveyed the field and found it to be unsettled with great diversity of opinion as to how to proceed (Weintraub 1979). Among the luminaries surveyed were Hicks (1939), Lange (1944), Klein (1947), Patinkin (1955), Glower (1965), Leijonhufvud (1967), and Barro and Grossman (1971). Since then, interest in the question has continued with an undiminished level of unsettled contentiousness (cf. Okun, 1980, Long and Plosser, 1983, Lucas, 1987, Benassy, 1993, Hahn and Solow, 1995, Howitt, 1997, and Glower, 1997). This paper will demonstrate by numerical examples that some of the questions raised by Keynes (1936) can be addressed by a simple general equilibrium model. Since general equilibrium models proceed from individual optimizations, the microfoundations of such models are fully explicit. Thus any macroeconomic results that can be obtained from general equlibrium models will have fully explicit microfoundations. II The Model CONSIDER A MINUSCULE CLOSED ECONOMY consisting of fifteen hundred individuals, five produced goods, and a basic resource that is used in both production and direct consumption. Each of the produced goods is respectively produced by a monopoly firm with constant unit cost for any given resource price. One thousand of the individuals have only labor income, but each of the monopoly firms has a hundred stockholders who have both dividend and labor income. It is assumed that all profits are distributed as dividends and that each stockholder holds stock in one and only one firm. It is also assumed that all agents have access to free openbook credit with settlement required at the beginning of the next time period. For computational convenience it is assumed that all individuals have the same utility function. This basic setup has been used in the past to illustrate the welfare properties of various forms of industrial organization and taxation under conditions of full employment (Morrison, 1979, 1981, 1983, 1995). A major assumption of convenience in those studies was that dividends are correctly anticipated by the stockholders (it being implicitly assumed that labor income is correctly anticipated). If income is correctly anticipated and the monopoly firms fill orders at the prices they post, then Walras's law assures continuous equilibrium in the resource market. Thus if we are to construct a simple general equilibrium model that can address the questions raised by Keynes, this assumption must be relaxed. This will be done by introducing the variable S which is the fraction of dividend income that is anticipated. In the previous studies, S was implicitly assumed to be equal to one. We now assume that S can also be less than or greater than one. This will allow income and expenditure to diverge making the model analogous to early Keynesian models (cf. Chandler 1940). …