Neo-Classical Models with Two Income Classes

Abstract

In this chapter we relax the neo-classical assumption that the aggregate saving ratio is a constant and treat the two income groups separately. The classical savings function assumes that wage earners do not save and that capital owners (we will call them firms for simplicity) do not consume but reinvest all their income. A more general assumption adopted by Kaldor [4] and followed up by Pasinetti [6] and others, is to assume that wage earners save a proportion s_w and that firms save a different propor tion s of their respective incomes.¹ We thus have two classes of income receivers, workers and firms, receiving different incomes and saving different proportions of their incomes. Several studies have estimated short run consumption functions with cross-section data and shown that firms save on average a higher proportion of their income than workers at the same level of income.² Firms have strong needs for investment funds which are expected to yield high returns. They therefore plow back a good part of profits into the business which results in a higher saving-income ratio. While the empirical results are based on short run consumption functions, the motives for additional saving by entrepreneurs are powerful even in the long run. It is therefore of considerable interest to study growth models which assume different saving rates for the two classes of income receivers.