Does Inequality Affect the Perception of Needs?

This paper investigates how inequality affects what the poor consider necessary to purchase. Using detailed information on the consumption choices of a large sample of poor households in India, we first provide evidence that inequality tends to make luxuries more necessary to the poor (their income elasticity decreases). We then estimate a structural model of demand where exposure to inequality affects the perceived needs of the poor, taking into account their supply environment. To account for the endogeneity between preferences and the income distribution, we rely on national inequality shocks that followed the 1991 economic liberalization reforms, and instrument local inequality using a shift-share strategy. We find that (1) inequality increases the perceived need of the poor for luxuries and (2) this preference shift generates significant expenditure reallocation at the expense of calorie intakes. On average, the calorie loss is about a fourth of the daily calorie intake