The rich are not like you and me: Income, price dispersion, and consumption

Abstract

This paper studies the impact of imperfect competition on life-cycle consumption profiles and consumption-risk sharing, along with its policy implications. We develop a framework by incorporating the Shapley-Shubik market game into a stochastic overlapping generations model. We characterize the inverse income-marginal price relationship under market power, where wealthy agents face lower prices for identical goods compared to a perfectly competitive economy. We present several novel findings due to the additional price effect channel arising from price dispersion. First, we show that income-dependent prices in an imperfectly competitive economy lead to a failure of consumption smoothing and generate hump-shaped consumption profiles without other frictions. We also demonstrate that the market power of agents increases consumption volatility and worsens consumption-risk sharing due to the double luck effect resulting from price dispersion caused by income shocks. The additional volatility from imperfect competition creates a complementary welfare loss. Lastly, we illustrate a severed link between fiscal and monetary policy in improving welfare in an imperfectly competitive economy, as monetary policies reinforce the inverse income-price relationship and adversely affect the poor, while fiscal policies do not.