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Abstract: We develop a two sector growth model to understand the relation between inequality and growth. Agents, who are endowed with different levels of knowledge, select either into a retail or a manufacturing sector. Agents in the manufacturing sector match to carry out production. A by-product of production is creation of ideas that spill over to the retail sector and improve productivity, thereby causing growth. Ideas are generated according to an idea production function that takes the knowledge of all the agents in a firm as arguments. We go on to study how an increase in the inequality of the knowledge distribution affects the growth rate. A change in the distribution not only affects the occupational choice of agents, but also the way agents match within the manufacturing sector. We show that if the idea generation function is sufficiently convex, an increase in inequality raises the growth rate of the economy.
Keywords: Inequality, growth, idea generation, matching, knowledge
JEL Classification: O30, O40, O41