Abstract

Digital transactions are becoming an increasingly common medium of exchange in everyday life. However, their impact on income inequality remains insufficiently understood. The purpose of this paper is to investigate the relationship between the digitization of the economy and income inequality across heterogeneous agents differentiated by skill. We propose an income-digitization model that expresses income inequality as a function of two parameters: the level of digitization in the economy, characterized by internet penetration, and the effort cost associated with digital participation, which depends on agents’ education levels. A theoretical model is developed to examine how these factors interact to shape both intra- and inter-skill group income
distributions. Using the concept of Lorenz Dominance, the model compares pre- and post-digitization income to assess shifts in inequality, and we use simulation to understand the implications from the theoretical exercise. As digitization expands, the results suggest that inequality is reduced among the low-skilled group, but it increases between the low- and high-skilled groups. However, the threshold for digital participation declines, lowering the effective effort cost and enabling broader inclusion. This effect is further amplified by a targeted policy intervention in the form of a subsidy, which reduces the effort cost by between 7.89% and 11.32% across increasing levels of digitization. The results highlight the role of the monopoly government in reducing
exclusion for low-skilled agents.