By Richard M. H. Suen
This paper presents a dynamic competitive equilibrium model with heterogeneous time preferences that can account for the observed patterns of wealth and income inequality in the United States. This model generalizes the standard neoclassical growth model by including (i) a demand for status by the consumers and (ii) human capital formation. The first feature prevents the wealth distribution from collapsing into a degenerate distribution. The second feature generates a strong positive correlation between earnings and wealth across agents. A calibrated version of this model succeeds in replicating the wealth and income distributions of the United States.
It is surprisingly difficult to replicate the distribution of wealth. One way to do it is by assuming heterogeneous preferences, but this requires more heterogeneity than what would be reasonable. Richard Suen gets here increasing returns to heterogeneity by adding human capital formation (richer people can get even richer) and wealth in the utility function (people want to hold wealth, not just consume it). Are these reasonable assumptions?