DP9831 Market Size, Entrepreneurship, and Income Inequality

Author(s): Kristian Behrens, Dmitry Pokrovsky, Evgeny Zhelobodko
Publication Date: February 2014
Keyword(s): entrepreneurship, heterogeneous agents, income inequality, market size, monopolistic competition
JEL(s): D31, D43, L11, L26
Programme Areas: International Trade and Regional Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=9831

We develop a monopolistic competition model with two sectors and heterogeneous agents who self-select into entrepreneurship, depending on entrepreneurial ability. The effect of market size on the equilibrium share of entrepreneurs crucially hinges on properties of the lower-tier utility function for differentiated varieties – its elasticity of substitution and its Arrow-Pratt index of relative risk aversion. We show that the share of entrepreneurs, and the cutoff for self-selection into entrepreneurship, can increase or decrease with market size. The properties of the underlying ability distribution largely determine how income inequality changes with market size.