The Urban-Rural Disparity: A Demand Side Analysis

Abstract

The urban-rural disparity is a common phenomenon in most developing economies. In particular, this disparity is strengthened by the household registration (Hukou) system in China. Chinese economy, as well as its income inequality, rose dramatically in last decades. Most researches show that urban-rural disparity is an important source of income inequality. In this paper we study the impact of this disparity on innovation through the demand for quality goods. For simplicity, we assume that there are two types of consumers: rich people living in the urban and poor people living in the rural area. The income distribution is measured by the population share of the poor and the relative income of the poor. The larger the income difference between the rural and the urban area, the more individuals migrate to the city in order to improve their income. Firms first invent quality goods, and then produce them in an oligopolistic market. Rich consumers have a higher willingness to pay for the better quality than the poor. Hence, the firms’ profit depends on the income distribution of consumers. We focus on the separating equilibrium, where goods of different qualities are sold to different consumers. In this equilibrium, a lower relative income of the poor is good for innovation, while a larger population share of the poor is bad.