Föllmi, RetoRetoFöllmiZweimüller, JosefJosefZweimüller2024-09-022024-09-022010-02https://boris-portal.unibe.ch/handle/20.500.12422/36746We explore how the underemployment problem of less-developed economies is related to income inequality. Our crucial assumption is that consumers have non-homothetic preferences over differentiated products of formal-sector goods and thus that inequality affects the composition of aggregate demand via the price-setting behavior of formal-sector firms. We find that (i) high inequality divides the formal sector into mass producers (which charge low prices that are within the reach of the poor) and exclusive producers (which charge high prices and sell only to the rich); (ii) high inequality generates an equilibrium where many workers are crowded into the informal economy; and (iii) an increase in subsistence productivity raises the wages of unskilled workers and boosts employment due to the higher purchasing power of poorer households.en300 - Social sciences, sociology & anthropology::330 - Economicsworking_paper10.7892/boris.145726E. Macroeconomics and Monetary Economics::E2 Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy::E25 Aggregate Factor Income DistributionD. Microeconomics::D3 Distribution::D30 GeneralD. Microeconomics::D4 Market Structure, Pricing, and Design::D42 MonopolyL. Industrial Organization::L1 Market Structure, Firm Strategy, and Market Performance::L16 Industrial Organization and Macroeconomics: Industrial Structure and Structural Change • Industrial Price IndicesE. Macroeconomics and Monetary Economics::E2 Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy::E24 Employment • Unemployment • Wages • Intergenerational Income Distribution • Aggregate Human Capital • Aggregate Labor Productivity