Dynamic Models of Heterogeneous Economics with Applications to Poverty and Business Cycles

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A large debate exists in public policy over the efficacy of anti- poverty programs. At the same time, research in sociology has concluded that an essential characteristic of inner city poverty is its persistence. Most of the recent analyses of poverty suffer from several weaknesses due to the lack of emphasis on poverty as a dynamic process. In particular, these studies generally do not attempt to explain how nonpoor families ever become poor, not do they attempt to explore how some poor families can escape poverty. Further, little attention has been given to the dynamics of neighborhood formation, which is essential to understanding how policy initiatives, such as public housing, school finance equalization or busing can reverse poverty. The contribution of this project comes from studying the emergence of poverty and inequality as outcomes of a dynamic process. The project constructs an explicitly dynamic and stochastic model of neighborhood formation, human capital formation and occupational achievement. The goal of this research is to understand how community influences on human capital formation can interact with endogenous community formation to produce rich and poor communities within the same economy. The large sample of parents and offspring from the Panel Study on Income Dynamics is combined with per pupil expenditure data available from states' Boards of Education in order to test the substantive and policy implications of the theoretical research. This project has three overall goals. First, it continues to the development of stochastic process methods of modelling heterogenous economies. These methods should be generally useful in developing dynamic models of incomplete markets and coordination failure. Second, this work is applied to the study of the dynamics of poverty and ghetto formation. Third, a class of coordination-based business cycle models are analyzed in order to better understand the role of incomplete markets in aggregate fluctuations.