The macroeconomics of Model T

We study a model of growth and mass production. Firms undertake either product innovations that introduce new luxury goods for the rich; or process innovations that transform existing luxuries into mass products for the poor. A prototypical example for such a product cycle is the automobile. Initially an exclusive product for the very rich, the automobile became affordable to the middle class after the introduction of Ford’s Model T, "the car that put America on wheels". We present a model of non-homothetic preferences, in which the rich consume a wide range of exclusive high-quality products and the poor a more narrow range of low-quality mass products. In this framework, inequality affects the composition of R&D through price and market size effects. The inequality-growth relationship depends on how mass production affects productivity; and on the particular dimension of inequality (income gaps versus income concentration). Our model is suffi ciently tractable to incoporate learning-by-doing, oligopolistic market structures, and quality upgrading. ∗University of St. Gallen, Departement of Economics SIAW, Bodanstrasse 8, CH-9000 St.Gallen, Tel: +41 71 224 22 69, Fax: +41 71 224 22 98, email: [email protected] †University of Zurich, Institute for Empirical Research in Economics, Muehlebachstrasse 86, CH-8008 Zürich, e-mail: [email protected]. ‡University of Zurich, Institute for Empirical Research in Economics, Muehlebachstrasse 86, CH-8008 Zürich, Tel: +41-1-634 37 24, Fax: +41-1-634 49 07, e-mail: [email protected]. Josef Zweimüller is also associated with CESifo and IZA. §We thank Daron Acemoglu, Philippe Aghion, Josef Falkinger, Winfried Koeniger, Kiminori Matsuyama, Fabrizio Zilibotti, seminar participants at the NBER Summer Institute, University of Torino, Queen Mary College London, and University of Zurich for valuable discussion, as well as Andreas Steinhauer for excellent research assistance.