THE EFFECT OF INCOME DISTRIBUTION AFTER BANKRUPTCY

Mustafa nar, Muhammet Emre ahinolu

Abstract
This model examines the effect of different allocations of income after bankruptcy on
economy. In this model, the bankruptcy and the shareholders are simplified to a case of an
allocation of wealth among two siblings after the death of a legator. In this part it is assumed
that the legator did not know the time when he will die and determines the saving rates
assuming that he will live infinitely. When he died suddenly his saving are bequeathed his
descents in the next period. By assuming that they have different consumption patterns we
calculated the consumption and saving rates they choose. Also we assumed different
allocations for several purposes such as fair division. Then the results are evaluated in terms
of economic criterion. Many models assume a representative agent and constructs the model
on this assumption. Since our model assumes agents with different consumption and saving
the we could consider the case of heterogeneous households. We evaluated the results of the
heterogeneous households and we showed that the representative agent model is equivalent to
taking the average of the heterogeneous households.

Keyword: heterogeneous households

1.Introduction
The allocation of the income or assets after bankruptcy always become an important
problem throughout the history. The division of legacy between siblings always become a
controversial issue in the society. The problem of fair division still exists and it is frequently
encountered. We considered different allocations by assuming the division of the income
among two siblings. The main assumption is that the two siblings have different consumption
habits so the utility they take from consumption is different. This is represented with different
utility functions. Then the problem is modelled as a sequential move game with complete
information. Firstly, each of the shareholders assumes a quantity that left from the legator and
then they determine their consumption and savings according to maximization of their utility
functions. Then a person, who knows their utility functions and preferences, decides how the
legacy is divided among these shareholders by considering different rules for their utility. The

results for different parameters are compared and explained accordingly. In the second part we
investigated the effect of the different consumption and saving decisions of the agents. It is
showed that the results of averaged heterogeneous household is the same as representative
agent model.
2. The Model
Assume that the after the sudden death of the legator the quantity he left is
b=Rt +1 st . This amount will be distributed between two siblings such as b=x1 + x 2 . A
mediator will decide on the quantities

x 1 and

x 2 according to different rules. Also we

assumed different utilities from the consumption for two shareholders. In the period after the
division the income levels of the shareholders will be w+ x 1 and w+ x 2 . At this stage
we assumed that the x1 and x2 are exogenous variables for the agents. They are determined
by the mediator and the agents decides their consumption and saving by taking this amount as
given. As a result the utility function of the first agent is
U 1 ( c 1t ,d 2 t +1 )= 1 ln ( c 1 t ) + Bln(d1 t +1 ) Subject to w+ x 1=c1 t + s 1t

U 2 ( c 1t ,d 1 t +1 )= 2 ln ( c 2 t ) + Bln(d 2t +1 )

For the second agent

subject to

w+ x 2=c 2t + s 2 t

According to this utility functions when agents assume an income level as an exogenous
variable their consumption and saving as the followings.
s 1 t=

B
(w+ x 1)
B+ 1

1
and c 1 t= B+ 1 ( w+ x 1)

s 2 t=

B
(w+ x 2)
B+ 2

2
c
=
( w+ x 2)
2
t
and
B+ 2

The mediator will be aware of the preferences of the agents. According to different rules he
will decide on the quantities x 1 and x 2 .

a)
Utility Maximizer Mediator

The purpose of the mediator is to maximize the total utility of the shareholders. The total
utility is given as the following.

(5)

The solution of the problem gives us the

x 1 and

x 2 as the following.

(6)
(7)

(3) ve (4) te x1 x2 yi yerine koy.

B(2 w+b)
If we rearrange the equations (11) and (12) we can see that s 1 t=s 2t = 2 B+ +
1
2

Interestingly, the maximization of the total utility of agents shows that the saving of the agents
must be equal.

b)
Utility Equalizer Mediator
In this case we assume a mediator which tries to equalize the utilities of the
shareholders.
(8)

When this equation is simplified the result is

(9)

c)
Saving Maximizer Mediator
In this case we assume that a mediator which tries to maximize the total savings of the
shareholders. Since we know the saving rates of the shareholders when the quantities are

given exogenously to the agents, we can write the total savings of the agents as a function of
x1 .
10)
The derivative of s 1 +s 2 with respect to
values

x 1 is a constant whose sign depends on the

1 and 2

(11)
If gamma2 is greater than gamma1 the maximum value of the s1+s2 is at x1=b. This shows
that when the second player is more intensive to consume, gamma2 is greater than gamma1
and the saving maximizer mediator will give the whole amount to the first agent. The result is
consistent with our intuitions. Also this is the best solution for the maximum growth rate since
the maximum value of the capital stock is transferred to next generation. Obviously, giving
whole properties to a person is not a fair distribution.

Household heterogeneity and Growth Models

We modelled a situation where a wealth will be distributed among two agents after the
death of the legator. We assumed that the agents have different consumption and saving
decisions. In many models, we considered a single household as representing the entire
economy. The important question is whether the behaviour of this single household is really
equivalent to what we would get if we averaged the behaviour of many heterogeneous
families.
In Solow-Swan model, the saving rate is an exogenous variable which is taken as
constant for all households. So our model is not applicable to Solow model since the agents
have different saving rates due to their utility functions. So we can extend the Ramsey model
to allow for various forms of household heterogeneity as Caselli and Ventura (2000) did.
Following their analysis, we assumed J households. The situation above is occurred at J*n
households which means the population growth rate is n, since two agents replaced with an
single agent.

We can examine the results of the model by making some assumptions. Firstly we can
consider the utility maximize mediator. If we take 1 = 2=1 Then the total saving at
this period(t+1) will be Jnb +J( 1n )b=JnRt +1st + J( 1n )Rt +1s t =
JR t+1s t . The saving per capita is

JRt +1st
j(1+n)

and if

Rt +1=1+r

and if r=n the

saving per capita will not change so the capital per capita will not change. This is an expected
result since the assumption we made is a representative household. But the interesting is that

the condition above is satisfied when

1 + 2=2 . Which shows that for the utility

maximizer mediator the representative agent model provides the correct description of the
average variables of an economy populated with the assumed form of heterogeneous agents.
The extension to include heterogeneity also allows for a study of the dynamics of inequality.

Lets consider the saving maximizer mediator case. This is the best case for the growth
since it maximizes the savings but it is not a fair allocation since it gives all the wealth to the
one person. If this person has the same utility with the legator, the saving rate again will be
the same.

Conclusion
In this research we investigated the different types of income allocation and their
effects on economy. We modelled the income allocation after a bankruptcy as a division of
inheritance after the death of a legator. We modelled this situation very simple. This is also a
very useful model to explain the asset distribution of a company among the shareholders after
bankruptcy. We assumed two shareholders and a mediator which decides on the allocation
among the shareholders. We considered different rules for allocation. One of them is the
maximization of the total utility of the shareholders. As a result, we found the shares of the
agents but the result may not be fair since it did not consider the individual utilities. Secondly,
we assumed equal utilities for the agents and we found a relation between X1 and X2. This
one is the fairest distribution since the utilities are the same. Lastly we assumed a mediator
which has a purpose of maximum savings. Then he will choose the agent which is less
intensive to consume and gives the total wealth to this person. This case is better in terms of
growth rate because the capital stock which transferred to next generation is the highest but
obviously it is not fair. This situation shows that there is a trade-off between fair distribution
and maximum growth rate.
In the second part of the research we investigated the effect of heterogeneous
households to the growth. We used Ramsey model since the Solow model takes the saving
rate as an exogenous variable. Our results show that assuming a representative agent is
equivalent to what we would get if we averaged the behaviour of many heterogeneous
families. This extension is that the aggregation of individual behaviour still corresponds to a
representative agent model, in the sense that the economy wide average variables, evolve as
they would with a single agent who had average values of initial wealth, labor productivity
and preferences. The results from the Ramsey model are robust to this extension to admit
heterogeneous preferences.

References
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doi:10.1016/j.mathsocsci.2014.09.002

2) Aroujo, Aloisio and Pascoa, Mario. Bankruptcy in a model of unsecured claims.

Economic Theory 20 (2002): 455-481. doi:10.1007/s001990100228

3) Francesco Caselli; Jaume Ventura. A Representative Consumer Theory of Distribution

The American Economic Review, Vol. 90, No. 4. (Sep., 2000), pp. 909-926.