Does Inequality Affect the Perception of Needs?

Abstract

This paper investigates how inequality affects what the poor consider necessary to purchase. Using detailed information on the consumption choices of a large sample of poor households in India, we first provide evidence that inequality exposure tends to make luxuries more necessary (their income elasticity decreases). We rely on national inequality shocks that followed the 1991 economic liberalization reforms, and instrument local inequality using a shift-share strategy. We then estimate a structural model of demand where inequality exposure affects perceived needs, taking into account the supply environment. We find that (1) inequality increases the perceived need of the poor for luxuries and (2) this preference shift generates significant expenditure reallocation at the expense of calorie intakes. Counterfactual simulations show that this preference channel accounts for three fourth of the decline in calorie consumption of the poor over the period.