Each firm also has a beginning-of-period<sup>set-upor fixed cost x,and thissetup costis drawn at random</sup> from a known cumulative distribution<sup>_H(x, m)_with0</sup><sup>_< x_<1. This distributionis parameterizedbythe</sup> number _m:_ _H(x,m)_ = mx<sup>2</sup> + (1 **-** _m)x, m_ E _[-1,1]._ (2) If m = 0, the distribution<sup>isuniform;if</sup><sup>_m_>0thedistributionisskewedtowardslowskilledor,</sup> alternatively, high x people,<sup>andthe converseariseswhen</sup><sup>_m_< 0.Wedo supposethis set upcostvaries</sup> inversely with talent, that<sup>is,it takesbothtalentand aninitial investmentto starta businessbutthey</sup> are negatively correlated<sup>Moregenerally,the cumulativedistribution</sup><sup>_H(x, m)_isa crude wayto capture</sup> and allow estimation of the<sup>distributionof talentinthe populationand is not an unusualspecificationin</sup> the industrial organization literature<sup>7 ,e.g,Daset al.(1998),Veracierto(1998).Costx is expressedin</sup> the same units as wealth.<sup>Everyagentisbornwithaninheritanceorinitialwealth</sup><sup>_b._The distribution</sup> of inheritances in the population<sup>atdatet isgivenby</sup><sup>_Gt(b): Bt_-a[0,1]whereBtcR.4+ isthe changing</sup> support of the distribution at<sup>date t.Thetime argumenttmakes explicitthe evolutionof Btand</sup><sup>**Ct**over</sup> time. The beginning-of-period<sup>wealth</sup><sup>_b_andthe costxare the onlysourcesof heterogeneityamongthe</sup> population These are modelled as independent<sup>ofoneanotherin thespecificationusedhere,andthis</sup> gives us the existence of a _unique_<sup>steady state. If correlationbetweenwealthand abilitywere allowed,we</sup> could have poverty traps,<sup>asinBanerjeeandNewman(1993). Wedo recognizethatinpracticewealth</sup> and ability may be correlated.<sup>Inrelatedwork,Paulson andTownsend(2001)estimatewiththe same</sup> data as here a version of the<sup>Evansand Jovanovic(1989)modelallowingthemean of unobservedability</sup> to be a linear function of wealth<sup>andeducationTheyfind the magnitude of bothcoefficientsto be small8 .</sup> All units of labor can be hired<sup>atacommonwagew,tobedetermined in equilibrium(thereis no</sup> variation in skills for wage<sup>work).The onlyothertechnologyisa storagetechnology whichcarries goods</sup> from the beginning to the<sup>endof the periodata returnofunity.Thiswouldputalowerbound on the</sup> gross interest rate in the corresponding<sup>economywithcreditandin anyeventlimitsthe input</sup><sup>_k_firms</sup> wish to utilize in the production<sup>of outputq,even in theeconomywithout credit.Firms operateincities</sup> and the associated entrepreneurs<sup>and workersincura commoncost of livingmeasured by the parameter</sup> v,.

The choice problem of the entrepreneur<sup>is presentedfirst.</sup> where _7r(b,_ x, _w)_ denotes the<sup>profitsof thefirmwithinitial wealth</sup><sup>_b,_withoutsubtractingthe setupcost</sup> x, given wage w. Since<sup>creditmarketshavenot yetbeenintroduced,capitalinputk cannotexceedthe</sup> initial wealth _b_ less the<sup>setupcost xasin(3).Thisisthe keyfinanceconstraintof the model.Itmay</sup> or may not be binding depending<sup>on</sup><sup>_x,b_andw.Moregenerally,somefirms may produce,butif wealth</sup> _b_ is low relative to cost<sup>x,theymaybe constrainedincapitalinputuse</sup><sup>_k,_that is,forconstrainedfirms,</sup> wealth b limits input k. Otherwise<sup>unconstrainedfirmsareall alikeandhaveidenticalincomesbefore</sup> netting out the cost x. The<sup>capitalinput</sup><sup>_k_canbezero butnotnegative.</sup>

**7In** extended models this<sup>wouldbetheanalogto the</sup><sup>**distribution**ofhuman</sup><sup>**capital,**although</sup><sup>**obviouslythe**education</sup> **investment decision is** not<sup>modelled here</sup>

SWe also **estimate** the LEB<sup>model forvarious</sup><sup>**stratifications of**wealth,e g.,above</sup><sup>**and**belowthe median,tosee</sup><sup>**how**</sup> parameter **m varies** with<sup>wealthThisway,wealth and talentare allowedto be correlated.Even though the point</sup><sup>**estimates**</sup> of **m vary significantly,** simulations<sup>with thedifferentestimates</sup><sup>**ofm are**roughly</sup><sup>**similar.**</sup> 5