ECONOMIC INEQUALITY

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ECONOMIC INEQUALITY
CHAPTER
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Objectives

• After studying this chapter, you will able to
• Describe the inequality in income and wealth in
  the United States and the trends in inequality
• Explain the features of the labor market that
  contribute to economic inequality
• Describe the scale of income redistribution by
  government

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Rags and Riches

• Homelessness and abject poverty exists alongside
  extreme wealth.
• What determines the distribution of economic
  well-being?
• How much redistribution does government do to
  limit extreme poverty?

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Measuring Economic Inequality

• The census bureau defines a households income as
  money income, which equals market income plus
  cash payments to households by the government.
• Market income equals wages, interest, rent, and
  profit earned by the household in factor markets,
  before paying income taxes.

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Measuring Economic Inequality

• The Distribution of Income
• Figure 18.1 shows the distribution of income
  across the 106 million households in the United
  States in 2001.

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Measuring Economic Inequality

• The mode income is the most common income and was
  about 13,000.
• The median income is the level of income that
  separates the population into two groups of equal
  size and was 42,228.
• The mean income is the average income and was
  58,208.

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Measuring Economic Inequality

• A distribution in which the mean exceeds the
  median and the median exceeds the mode is
  positively skewed, which means it has a long tail
  of high values.
• The distribution of income in the United States
  is positively skewed.

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Measuring Economic Inequality

• Figure 18.2 shows the distribution of income
  shares for the United States in 2001.

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Measuring Economic Inequality

• The poorest 20 of the population in 2001
  received only 3.5 of the total income.
• The middle 20 of the received 14.5 of total
  income.
• The richest 20 received 50.1 of total income.

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Measuring Economic Inequality

• The Income Lorenz Curve
• The income Lorenz curve graphs the cumulative
  percentage of income earned against the
  cumulative percentage of households.
• Figure 18.3 shows the income Lorenz curve for the
  income shares in Figure 18.2.

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Measuring Economic Inequality

• The vertical axis of a Lorenz curve is the
  cumulative percentage of total income.
• The horizontal axis is the cumulative percentage
  of households.

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Measuring Economic Inequality

• If everyone has the same income, the income
  Lorenz curve is a 45 degree line from the lower
  left corner to the upper right corner. This line
  is called the line of equality.
• The Lorenz curve shows the cumulative
  distribution of income.

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Measuring Economic Inequality

• The closer the Lorenz curve is from the line of
  equality, the more equal is the distribution of
  income.

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Measuring Economic Inequality

• The Distribution of Wealth
• Wealth is the value of all the things that are
  owned by a household at a given point in time.
• The distribution of wealth is another way of
  examining the degree of economic inequality.

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Measuring Economic Inequality

• A wealth Lorenz curve measures the distribution
  of wealth in the same way an income Lorenz curve
  measures the distribution of income.
• The distribution of wealth is even more unequally
  distributed than income.

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Measuring Economic Inequality

• Wealth Versus Income
• Wealth is a stock of assets and income is a flow
  of earnings that result from a given stock of
  wealth.
• The reason that wealth is more unequally
  distributed than income is that wealth does not
  measure the quantity of human capitalonly income
  reflects the quantity of human capital.
• Because wealth does not reflect potential for
  income from human capital, income is a more
  accurate measure of economic inequality.

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Measuring Economic Inequality

• Annual or Lifetime Income and Wealth?
• A households income and wealth change over time.
• A household headed by a young person starts out
  with moderate income and accumulates wealth for
  retirement years.
• A middle-age headed household is in its highest
  earning years and enjoys the highest level of
  wealth.
• A households headed by an older, retired person
  has lower earning and is consuming, rather than
  accumulating, its wealth.

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Measuring Economic Inequality

• The Gini Ratio
• To measure inequality as an index number, we use
  the Gini ratio, which equals the ratio of blue
  area to the red area in the two figures below.

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Measuring Economic Inequality

• The Gini Ratio
• With perfect equality, the Lorenz curve is the
  line of equality and the Gini ratio is zero.

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Measuring Economic Inequality

• The Gini Ratio
• With the most extreme inequalityone person has
  all the incomethe Lorenz curve runs along the
  axes and the Gini ratio is one.

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Measuring Economic Inequality

• The Gini Ratio
• The closer the Gini ratio is to one, the more
  unequal is the distribution of income. In 2001,
  the U.S. Gini ratio was 0.45.

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Measuring Economic Inequality

• Trends in Inequality
• Figure 18.5 shows trends in the U.S. Gini ratio.
• The trend is toward greater inequality.

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Measuring Economic Inequality

• Who Are the Rich and the Poor?
• Figure 18.6 on the next slide identifies the five
  characteristics that appear to influence the
  amount of income earned by a household.
• These characteristics are
• Education
• Type of household
• Size of Household
• Age of householder
• Race

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Measuring Economic Inequality
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Measuring Economic Inequality

• Poverty
• Poverty is a situation in which a households
  income is too low to be able to buy the
  quantities of food, shelter, and clothing that
  are deemed necessary.
• Poverty is a relative concept.
• In 2000, the poverty level calculated by the
  Social Security Administration for a four-person
  family was 17,761.
• 31.1 million Americans lived in households with
  incomes below this poverty level, which amounts
  to 11.3 percent of the total population at that
  time.

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Measuring Economic Inequality

• There has historically been an over-representation
  of minority households living in poverty in the
  United States. In the year 2000, 9.4percent of
  white households lived in poverty while 21.7
  percent of Hispanic households and 31.3 percent
  of black households lived in poverty.

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The Sources of Economic Inequality

• Inequality arises from unequal labor market
  outcomes and from unequal ownership of capital.
• Two significant features of labor markets create
  income differences among individuals
• Human capital differences
• Discrimination.

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The Sources of Economic Inequality

• Human Capital
• The more human capital a person possesses, the
  more income that person likely earns, other
  things remaining the same.
• On the demand side of the labor market,
  high-skilled workers generate a larger marginal
  revenue product than low-skilled workers.
• So firms are willing to pay a higher wage rate
  for high-skilled labor.

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The Sources of Economic Inequality

• Figure 18.7(a) shows the difference in demand
  curves for high-skilled versus low-skilled labor.

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The Sources of Economic Inequality

• On the supply side of the labor market,
  high-skilled workers incur a cost of acquiring
  their skillsmoney costs as well as time costs
• So high-skilled workers are willing to supply
  labor only at wage rates that compensate them for
  those costs, which exceed the wage rates at which
  low-skilled workers are willing to supply labor.

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The Sources of Economic Inequality

• Figure 18.7(b) shows the difference in supply
  curves for high-skilled versus low-skilled labor.

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The Sources of Economic Inequality

• The combination of higher demand and lower supply
  for high-skilled workers relative to low-skilled
  workers creates a higher equilibrium wage rate
  for those workers who have attained greater
  levels of human capital.

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The Sources of Economic Inequality

• Figure 18.7(c) shows the difference in
  equilibrium wages for high-skilled versus
  low-skilled labor.

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The Sources of Economic Inequality

• Figure 18.8 shows how technological change
  combined with skill differences have widened the
  gap between low incomes and high incomes.
• The demand for low-skilled labor has decreased
  and the wage rate has fallen.

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The Sources of Economic Inequality

• The demand for high-skilled labor has increased
  and the wage rate has risen.

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The Sources of Economic Inequality

• Discrimination
• While the level of human capital attained varies
  across households, discrimination alone does not
  explain all the observed inequality in income.
• If the levels of marginal revenue product of one
  race or one sex are perceived to be higher than
  that of another race or another sex, the
  equilibrium wages will vary across each racial or
  gender group of households, despite holding the
  level of human capital constant.

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The Sources of Economic Inequality

• If firms perceive white males to be more
  productive workers than black females, then the
  perceived marginal revenue product curves (which
  are the labor demand curves) for white men would
  be higher than that for black women.

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The Sources of Economic Inequality

• Figure 18.9 shows the potential effect of
  discrimination of the wage rates of white men and
  black women.
• If black women are discriminated against, the
  perceived MRP is lower and their wage rate and
  employment level decrease.

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The Sources of Economic Inequality

• If white men are discriminated for, the perceived
  MRP is higher and their wage rate and employment
  level increase.

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The Sources of Economic Inequality

• Economists disagree to the extent that
  discrimination pervades the labor market.
• One line of reasoning states that those firms
  that practice race or sex discrimination in the
  labor market would face higher production costs
  (pay higher wages for the same marginal revenue
  product) than those firms that do not.
• If this line of reasoning is correct, the profit
  margins for the firms practicing discrimination
  will be lower and that the market price of their
  goods and services would be higher than
  non-discriminating firms.

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The Sources of Economic Inequality

• Either way, the market pressures increase the
  opportunity cost to firms (and the consumers who
  buy their product) for practicing race or sex
  discrimination, eventually eliminating these
  practices.
• Another line of reasoning is that claims of sex
  discrimination can be explained by differences
  between the men and women regarding their
  willingness, on average, to specialize in
  providing income generating labor versus
  providing non-income generating labor in the home.

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The Sources of Economic Inequality

• More women than men work at home for a portion of
  their adult life while engaged in child rearing
  and/or running the household.
• This allocation of time means that womens wages
  will be lower, on average, than mens wages.
• Accounting for this difference in labor
  specialization has been found to explain much of
  the wage differentials between men and women.

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The Sources of Economic Inequality

• Unequal Ownership of Capital
• Income inequality is increased by the unequal
  distribution of wealth.
• Unequal wealth results from savings and wealth
  transfers between generations.
• There are two significant aspects of
  intergenerational wealth transfers that increase
  economic inequality
• Debt cannot be transferred across generations
• Marriage concentrates wealth

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Income Redistribution

• The governments in the United States use three
  main ways to redistribute income to alleviate
  some degree of economic inequality
• Income taxes
• Income maintenance programs
• Subsidized services.

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Income Redistribution

• Income Taxes
• The U.S. federal government and most state
  governments tax incomes.
• By taxing incomes of different levels at
  different tax rates, economic inequality can be
  decreased.
• A progressive income tax taxes household incomes
  at an average rate that rises with income.
• The U.S. income tax system and all state income
  tax systems are progressive income tax systems.

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Income Redistribution

• A regressive income tax taxes income at average
  rates that fall with income, thereby
  redistributing income away from poorer taxpayers.
• A proportional income tax (also called a
  flat-rate income tax) taxes income at a constant
  average rate for all income levels.

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Income Redistribution

• Income Maintenance Programs
• Three major types of programs provide direct
  payments to individuals
• Social Security Programs
• Unemployment Compensation
• Welfare Programs

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Income Redistribution

• Subsidized Services
• A great deal of income redistribution takes the
  form of subsidized services, where people other
  than those who pay for it consume the services
  provided.
• An example is primary and secondary public
  education, as well as state colleges and
  universities.
• The students at these institutions generally pay
  tuition and fees that range from 20 to 25 of the
  actual expenses for educating a college student.
• The families of these students enjoy a sizeable
  subsidy for acquiring human capital.

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Income Redistribution

• The Scale of Income Redistribution
• The extent of the government income
  redistribution can be determined by looking at
  the difference between market income and money
  income minus income taxes.
• In 2001, the poorest 20 percent of households
  received only 0.9 percent of total money income
  earned in the United States, but received 4.6
  percent of total market income.
• In 2001, the richest 20 percent of households
  received 55.6 percent of total money income
  earned in the United States, but received 46.7
  percent of total market income.

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Income Redistribution

• Figure 18.10 shows the influence of government
  income redistribution efforts in 2001.
• The distribution after taxes and benefits is
• more equal than the distribution of market
  income.

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Income Redistribution

• The three lower income groups gain
• and the highest income group loses.

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Income Redistribution

• The Big Tradeoff
• Redistributing income leads to a tradeoff between
  equity and efficiency, known as the big tradeoff.
  Programs to redistribute income are inefficient
  for three reasons
• The process of income redistribution uses up
  resources that could have otherwise been used for
  producing goods and services.
• Redistribution of income requires taxes to be
  imposed on the economy, which was shown in an
  earlier chapter to generate a deadweight loss in
  the markets that are taxed.

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Income Redistribution

• Income redistribution decreases the incentives
  for taxpaying workers to provide labor when
  leisure is a normal good (by decreasing income
  from work) and decreases the incentives for
  income assistance recipients to provide labor
  and earn income.
• A major challenge in the U. S. today is finding
  ways to assist the poorest identifiable group
  young minority women who have not completed high
  school, have dependent children, and live without
  a spouse in the household.

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Income Redistribution

• The long-term solution to their plight is
  education and job trainingacquiring human
  capital.
• The short-term solution is enforcing child
  support payments from absent fathers and former
  husbands, and providing welfare assistance. But
  it must be designed to minimize the disincentive
  to become self-sufficient.

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Income Redistribution

• Welfare reform occurred in 1996 when the
  Temporary Assistance for Needy Families (TANF)
  program was implemented.
• TANF is a block grant to the states, not an
  open-ended entitlement program for individuals.
• An adult member of a family receiving assistance
  must either work or perform community service and
  there is a five-year limit for receiving
  assistance.

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THE END