'Increasing the size of the pie', explained.

In the last 40 years economies around the world have been witnessing a rising trend in inequality. Form the USA to China and India,  have seen a rising gini coefficient(measure for economic inequality. Reducing inequality, keeping in view the recent changes in the global economy, has become imperative for various economies to get back on long term growth path after the recent global economic crisis. ). In this post I will try and explain the most commonly stated advantages of shrinking inequality, the argument in common parlance is metaphorically stated as ‘increasing the size of the pie’, pie here is the economy. First I have to explain some basic economic concepts.

Every person tends to consume a certain part of their income and save the rest, but this tendency begins to change as the person’s income rises. In economics, the proportion of income that a person consumes is called Marginal Propensity to consume (mpc), the fraction of every additional rupee spent for consumption, for a wealthy person mpc is quite low and the mpc for a poor person is high, to understand this, think about what a wealthy person would do if he was given thousand rupees? he would save most of it, wealthy people tend to save most of every additional rupee that they earn as their basic consumption is already taken care of; on the other hand if we give a poor person the same thousand rupees he would use it to buy goods for consumption, rather than putting it in the bank. When an economy has high inequality, a larger portion of the economy’s income is going to a small fraction of the population, as a result, we see the absence of purchasing power for a majority of the population, and this creates the classic Keynesian problem of insufficient aggregate demand.

When we shrink inequality the domestic demand is boosted thus leading to the growth. While rising economic inequality presents a slew of many other problems one of them is a rising inequality of opportunity which is explained well by David Brooks in this NYT article. Nobel laureate Joseph Stieglitz explores this in a much more detail in his book the Price of Inequality 

http://www.guardian.co.uk/books/2012/jul/13/price-inequality-joseph-stiglitz-review