Microfinance (small scale lending to the poor) is integrated into a dynamic macroeconomic model of income distribution. Two-period-lived agents, belonging to overlapping generation of dynastic families, choose between three alternative occupations - subsistence production, small-scale project investment and large-scale project investment. Subsistence activity is costless and riskless, whilst project investment is the opposite and may require external funding from financial institutions with imperfect powers of contract enforcement. In the absence of microfinance, only large-scale, collateralised loans are available through the traditional banking sector. Under such circumstances, initial inequalities persist as only the wealthy are able to acquire these loans, and as the small-scale enterprise is either not feasible or not profitable. With the introduction of microfinance, this venture is made both possible and attractive through the provision of non-collateralised loans and other features of microlending arrangements. Poverty and inequality are reduced as a result.
