Notesale: Turn your study into money

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There is a TRADE-OFF between conspicuous consumption and education
Poor people spend a higher proportion of income on conspicuous consumption
The alternative is that accumulating human capital over time means less spent on cc (x)
Education provides a signal

Simple case:
b = investment in education from parent for next generation
y= income of parent
The parents’ investment in the education of their children will translate to increased income of their children when they
become adults
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This is the shape it has under the assumption of homothetic preferences and a standard production function (increasing
and concave - positive marginal products but diminishing)
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In the first lecture, we gave ideas for the mechanisms which generate poverty traps - they basically say:
if the parents are poor they cannot invest much into the education of their children, so their children will become poor
and poverty will persist - a poverty trap
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So in order for us to have a poverty trap we need a figure that looks like this:
That the phi function crosses the 45 degree line more than once
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When the phi function lies above the 45 degree line income is growing over time, and if it is below income is shrinking
over time
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Everyone above P will converge to the high income steady state
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We cannot just combine standard assumption to generate a poverty trap - we need this phi function to be, at some
range convex, not just continuously concave
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What the literature did about this:
Most of the literature kept the assumption about preferences (straight line), and played with the technology
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With Dasgupta-Ray (1986) it is a story about nutrition, and in their mechanism, poor people do not have enough money
to buy enough food
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And if they cannot work they cannot get
enough money to buy food, which generates a poverty trap
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We need to tell a story about the exact relationship between food consumption
and the ability to supply labour, and it cannot be this standard, decreasing concave relationship
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The production function in Dasgupta-Ray (1986) is how consumption of food translates to the ability to provide labour
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The production function describes how food consumption translates into production
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The advantage of looking at the behaviour of the poor rather than technology, is that, empirically, it seems the right
approach
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At first, the assumption of linearity seems realistic, (going to university is not an increasing concave function) because
it is important to graduate from university
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This is indivisible
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Or a 1
year course
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If you think of an envelope of all these options, there is no reason to think that technology would be
anything other than a standard concave function
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When we look at the behaviour of the poor, one thing we see that is very clear: they save at a lower rate
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Not many people have looked at this: Moav is author of 3 of the papers
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/Dynan et al (2004) find that savings as a proportion of income increases with wealth, so assumption of homothetic
preferences is unrealistic - this justifies looking at the behaviour of the poor
In Moav (2002) we simply assume that this is the shape of the saving function (or function of investment in off-spring)
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Also, replace homothetic preferences with the assumption that the investment function in the education of the
children is increasing and convex
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(11:10)
/This type of behaviour cannot simply be justified by saying that poor live in ‘subsistence’ and their lack of wealth is selfperpetuating, generating a poverty trap in this way
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g, Obamza family) suggests that the poor can afford to invest in the education of their children, but do
not
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Poor people in poor countries have more children than rich people in rich countries
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So poor people live at subsistence, they don’t save, and only above some
threshold of income people start allocating their income to the education of their children
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The Obamza family do not send their children to school, even though the cost if $2
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At the
same time, they spend $22 a month on alcohol and phones
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We need a better explanation than simply saying ‘subsistence’
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Within countries, there is a correlation between education and fertility, and education and income
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(13:35)

In this paper there is a model in which poor people choose to have more children because they ? education and they
have a comparative disadvantage in educating their children because they choose a larger number of lower education
children and despite assuming homothetic preferences, this quality-quantity trade-off generates an investment function
which looks like this and a poverty trap
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e
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A key assumption according to Banerjee & Mullainathan (2007) is that there is a
difference between poor and wealthy, in that the fraction of income allocated to temptation goods is decreasing with
income
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This is true if temptation is just for donuts
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Temptation is not just for donuts - Ferrari/ jet/ etc
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Could go the other way: poor people are not even tempted to spend money on a donut because they’re so poor they
realise that they have to cut on healthier and more important stuff
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So by assumption you have this type of line:

But Banerjee & Mullainathan's (2007) story continues
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Here is the key story they tell: Today I know that tomorrow I will suffer from temptation
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From the point of view of myself today,
temptation in the future is a tax on my income
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My savings in the future will be taxed by temptation, which reduces the savings rate
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No, Banerjee & Mullainathan's (2007) assumption that poor individuals will reduce their savings today because they
know they will be tempted tomorrow could be wrong:
If individuals know they will spend more next period, they will save more this period, to compensate
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You may say the opposite: I will save more so that I have some income left after taxation
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e
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So we have to assume additionally that the substitution effect is greater than the income effect
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Result: we have savings rate increasing with income and persistence of poverty
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So same basic figures that generate a dynamical system
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Combined, we have a linear phi function
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This gives us endless growth dynamics and all dynasties will converge to a globally stable steady state
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This reduces their savings
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This comes
at the expense of other consumption and savings
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Model shows that regardless of income, everyone is allocating the same fraction of income to conspicuous
consumption
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BUT now let’s add the crucial mechanism to the story: that when education increases and with education income also
increases; people reduce the fraction of income allocated to conspicuous consumption
Now assume that as income increases (as a result of more human capital), the fraction of income spend in conspicuous
consumption is shrinking
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In this
example, there is this threshold below which individuals converge to the low income steady state, and above which
they enjoy constant growth of income
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What matters is that we have a threshold and below this people converge to a poverty trap, and above they converge
to a high income or endless growing steady state
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In terms of what you need to know for the exam - DO NOT NEED THE DETAILS OF THIS PAPER - You need to
understand ideas - UNLIKE GALOR-ZEIRA MODEL - which we do have to understand the details

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