We introduce non-homothetic preferences into an innovation-based growth model and study how income and wealth inequality affect economic growth. We identify a (positive) price effect—where increasing inequality allows innovators to charge higher prices and (negative) market-size effects—with higher inequality implying smaller markets for new goods and/or a slower transition of new goods into mass markets. It turns out that price effects dominate market-size effects. We also show that a redistribution from the poor to the rich may be Pareto improving for low levels of inequality.

We incorporate consumption indivisibilities into the Krugman (1980) model and show that an importer's per capita income becomes a primary determinant of “export zeros”. Households in the rich North (poor South) are willing to pay high (low) prices for consumer goods; hence, unconstrained monopoly pricing generates arbitrage opportunities for internationally traded products. Export zeros arise because some northern firms abstain from exporting to the South, to avoid international arbitrage. Rich countries benefit from a trade liberalization, while poor countries lose. These results hold also under more general preferences with both extensive and intensive consumption margins. We show that a standard calibrated trade model (that ignores arbitrage) generates predictions on relative prices that violate no-arbitrage constraints in many bilateral trade relations. This suggests that international arbitrage is potentially important.

In the past twenty years, the share of top incomes in Switzerland has risen, while exhibiting large variations. Switzerland is similar to European countries for the top 1% but closer to the United States for higher top income groups. With the synthetic control method, we close a time gap in the tax data, exploiting the fact that Swiss cantons changed their tax system at different points in time. Using social security data, which cover all top labor incomes, we document the growing importance of labor compared to capital incomes among top income earners in Switzerland.