China’s Household Consumption Decline Amidst Rising Income Inequality: A Theoretical and Empirical Study*

Chen Binkai
Central University of Finance and Economics, Beijing, China
Abstract: This paper studies the relationship between the widening urban-rural income inequality and weak household consumption demand in China. The theoretic model shows that households with higher income have lower average and marginal propensity to consume (APC and MPC), and that the larger the income gap is, the weaker household consumption demand becomes. This paper tests the theoretical model with the panel data of 28 Chinese provinces, municipalities and autonomous regions from 1978 to 2009. The results show that with an increase of RMB10,000 in income, household APC drops by 25.6 percent and MPC by 7.0 percent; and that if the income gap widens by one unit, household consumption rate drops by 6.5 percentage points. Simulation results reveal that the widening urban-rural income inequality caused an extra drop of 3.42 percentage points in household consumption rate from 2000 to 2008, which accounts for 30.8 percent of the total drop in household consumption rate during that period.
Key words: income inequality, consumption rate, life-cycle hypothesis

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