Föllmi, RetoRetoFöllmiMeister, UrsUrsMeister2023-04-132023-04-132011-01-01https://www.alexandria.unisg.ch/handle/20.500.14171/9465310.1257/mac.3.1.242We explore how the underemployment problem of less-developed economies is related to income inequality. Consumers have nonhomothetic preferences over differentiated products of formal-sector goods and thus inequality affects the composition of aggregate demand via the price-setting behavior of firms. We find that high inequality divides the formal sector into mass producers and exclusive producers (which serve only the rich); high inequality generates an equilibrium where many workers are crowded into the informal economy; and an increase in subsistence productivity raises the unskilled workers' wages and boosts employment due to the higher purchasing power of poorer households. (JEL D31, D43, E24, E26, J24)enjournal article