ch19 10e lecture ge

8/11/2019 Ch19 10e Lecture GE

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19ECONOMIC

INEQUALITY


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2012 Pearson Education


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Extreme poverty and extreme wealth exist side by side inevery major city in the United States and in most parts of the

world.

How many rich and poor people are there in the UnitedStates?

How does the distribution of income in the United Statescompare with that in other countries?

Are the rich getting richer and the poor getting poorer?

Or are incomes becoming more equal?


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The census bureau defines a households income as

money income, which equals market income plus cashpayments to households by the government.

Market incomeequals wages, interest, rent, and profitearned by the household in factor markets, before payingincome taxes.

Economic Inequality in the

United States


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The Distribution of

Income

Figure 19.1 shows the

distribution of incomeacross the 117.5 millionhouseholds in theUnited States in 2009.


United States


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The modeincome is themost common income andwas about $22,000.

The medianincome is thelevel of income thatseparates the populationinto two groups of equalsize and was $49,777.

The meanincome is theaverage income and was$67,976.


United States



A distribution in whichthe mean exceeds themedian and the median

exceeds the mode ispositively skewed, whichmeans it has a long tailof high values.

The U.S. distribution ofincome is positivelyskewed.


United States



Figure 19.2 showsthe distribution ofincome shares for

the United States in2009.


United States



In 2009:

The poorest 20% ofhouseholds receivedonly 3.4% of the total

income.

The middle 20%received 14.6% of

total income.The richest 20%received 50.2% oftotal income.


United States




United States

The Income Lorenz Curve

The income Lorenz curvegraphs the cumulative

percentage of incomeearned against thecumulative percentage ofhouseholds.



The vertical axis plots thecumulative percentage ofincome.

The horizontal axis is the

cumulative percentage ofhouseholds.

Economic Inequality in the United

States




States

If everyone has the sameincome,

the income Lorenz curve

is a 45 degree line fromthe lower left corner tothe upper right corner.This line is called the lineof equality.

The Lorenz curve showsthe distribution of income.



The Distribution of

Wealth

A households wealthis

the value of all thethings that it owns at apoint in time.

The distribution ofwealth is another way ofexamining the degree ofeconomic inequality.


United States



A wealth Lorenz curvemeasures thedistribution of wealth.

The distribution ofwealth is even moreunequally distributedthan income.


United States



Wealth or Income?

Wealth is a stock of assets and income is a flowofearnings that result from a given stock of wealth.

Wealth is more unequally distributed than income becausewealth does notmeasure the quantity of human capital.

Income reflects the quantity of human capital.

Because the distribution of wealth excludes human capital,the distribution of income is a more accurate measure ofeconomic inequality.


United States



Annual or Lifetime Income and Wealth?

A households income and wealth change over time.

A household headed by a young person starts out withmoderate income and accumulates wealth for retirementyears.

A middle-age headed household is in its highest income

years and enjoys the highest level of wealth.

A households headed by an older, retired person haslower income and is consuming, rather than accumulating,its wealth.


United States



Trends in Inequality

To measure inequality as an index number, we use theGini ratio, which equals the ratio of blue area to the red

area in the two figures below.


United States



With perfect equality, the Lorenz curve is the line ofequality and the Gini ratio is zero.


United States


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With the most extreme inequalityone person has all theincomethe Lorenz curve runs along the axes and theGini ratio is one.


United States


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The closer the Gini ratio is to one, the more unequal is thedistribution of income.

In 2009, the U.S. Gini ratio was a bit more than 0.46.


United States


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Figure 19.5 shows theU.S. Gini ratio from 1970to 2009.

The Gini ratio shows thatthe distribution of incomein the United States hasbecome more unequal.

Despite the change inthe definition in 1992, thetrend is still visible.


United States


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Poverty

Povertyis a situation in which a households income istoo low to be able to buy the quantities of food, shelter,

and clothing that are deemed necessary.

Poverty is a relative concept.

In 2009, the poverty level calculated by the Social Security

Administration for a four-person family was $21,756.

44 million Americans lived in households with incomesbelow this poverty level14 percent of the total populationin 2009.


United States


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The distribution of poverty by race is unequal:

In 2009, 9.4 percent of white Americans lived in povertycompared to 25 percent of Hispanic-origin Americans and

26 percent of African Americans.

Poverty is also influence by household status:

More than 28 percent of households in which the

householder is a female with no husband present hadincomes below the poverty level.

Despite the widening of the income distribution, povertyrates have fallen.


States


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Inequality in the World Economy

Which countries have the greatest economic inequality?

Which countries have the least and the greatest equality?

Where does the United States rank?

How much inequality is there in the world economy as awhole?


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Income Distributions inSelected Countries

Figure 19.6 illustratessome extremes and the

U.S. Lorenz curves.


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Global Inequality and Its Trends

The global distribution of income is much more unequalthan the distribution within any one country.

Of the world population:

50 percent live on $2.50 a day or less; 30 percent live onbetween $2.50 and $10 a day.

That is, 80 percent of the world population is very poor.

The average American has $115 a day.


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World Gini Ratio

The global distribution ofincome is becoming less

unequal.

Despite individual countriesare becoming moreunequal, incomes in poorercountries are rising fasterthan incomes in richcountries.


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The Sources of Economic Inequality

Inequality arises from unequal labor market outcomes andfrom unequal ownership of capital.

Three significant features of labor markets contribute to

income differences among individuals:

Human capital

Discrimination

Contest among superstars


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Human Capital

The more human capital a person possesses, the moreincome that person likely earns, other things remaining the

same.

On the demand side of the labor market, high-skilledworkers generate a larger value of marginal product thanlow-skilled workers.

So firms are willing to pay a higher wage rate for high-skilled labor.



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On the supply side of the labor market, high-skilledworkers incur a cost of acquiring their skillsmoney costsas well as time costs.

So high-skilled workers are willing to supply labor only atwage rates that compensate them for those costs.

The supply of high-skilled workers is smaller than thesupply of low-skilled workers.



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Trends in InequalityExplained

Technological change

Computers and laserscanners are substitutesforlow-skilled labor.

The demand for low-skilled

labor has decreased and thewage rate has fallen.



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New technologies and high-skilled labor arecomplements.

The demand for high-skilledlabor has increased and thewage rate has risen.

The gap between the wagerates of high- and low-skilledlabor has increased.



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Globalization

The entry of China and other developing countries into theglobal economy has lowered the prices of manufactured

goods and decreased the value of marginal product oflabor.

The demand for low-skilled labor has decreased and theirwage rate has fallen.

But a growing global economy has increased the demandfor high-skilled workers and their wage rate has risen.


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Discrimination

Human capital differences can explain some of theeconomic inequality we observe.

Discrimination is another possible source of incomeinequality.

If the value of marginal product of one sex (or race) is

perceived to be higher than that of another sex (or race),the equilibrium wage rates will vary across the gender (orracial) groups, despite holding human capital constant.



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Suppose that firms perceive white males to be moreproductive workers than black females.

Then the perceived value of marginal product of white

men would be higher than that of black women.

The demand for labor of white men is higher than thedemand for labor of black women.



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Figure 19.9 shows thepotential effect ofdiscrimination of whitemen and black women.

If black women arediscriminated against, theperceived VMPis lower.

Their wage rate andemployment leveldecrease.



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If white men arediscriminated for, theperceived VMPis higher.

Their wage rate andemployment levelincrease.



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Counteracting Forces

Economists disagree to the extent that discriminationpervades the labor market.

One line of reasoning states: Firms that discriminate wouldhave higher production costs (pay higher wages for thesame VMP) than those that do not.

If this line of reasoning is correct, firms practicingdiscrimination will have

1. Smaller profits margins.

2. Higher market prices.



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Either way, market pressures increase the opportunity costto firms for practicing discrimination, eventually eliminatingthese practices.

Differences in the Degree of Specialization

Another line of reasoning is that:

sex discrimination can be explained by differences

between the men and women regarding their willingness,on average, to specialize in earning a wage versus doingjobs in the home.



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More women than men work at home for a portion of theiradult life while engaged in child rearing and/or running thehousehold.

This allocation of time means that womens wages will belower, on average, than mens wages.

Accounting for this difference in labor specialization hasbeen found to explain much of the wage differentials

between men and women.



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Do Contests Among Superstars Explain the Trend?

Contests among superstars can explain large differencesin incomes.

Globalization has increased the market reach of thewinner in a winner-take-all contest and increased thespread between the winner and the runner up.



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Unequal Wealth

The inequality of wealth (excluding human capital) is muchgreater than the inequality of income.

This greater wealth inequality arises from two sources:

1. Life-cycle saving patterns

2. Transfers of wealth between generations

The significant aspects of intergenerational wealthtransfers that increase economic inequality is thatmarriage concentrates wealth.



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Income Redistribution

The three main ways governments in the United Statesredistribute income are

Income taxes

Income maintenance programs

Subsidized services


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Income Taxes

The U.S. federal government and most state governmentstax incomes.

By taxing incomes of different levels at different tax rates,economic inequality can be decreased.

A progressive income taxis one that taxes income at an

average rate that increases with income.

The U.S. income tax system and all state income taxsystems are progressive income tax systems.



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A regressive income taxis one that taxes income at anaverage rate that decreases with income.

A proportional income tax(also called a flat-rate income

tax) is one that taxes income at a constant average ratefor all income levels.



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Income Maintenance Programs

Three major types of programs provide direct payments toindividuals:

Social Security programs

Unemployment compensation

Welfare programs



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Subsidized Services

A great deal of redistribution takes the form of subsidizedservicesservices provided by the government at pricesbelow the cost of production.

An example is primary and secondary public education, aswell as state colleges and universities.

The students at these institutions generally pay tuition and

fees that range from 20 to 25% of the actual cost ofeducating a college student.

The families of these students enjoy a sizeable subsidy foracquiring human capital.



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The Big Tradeoff

Redistributing income leads to a tradeoff between equityand efficiency, known as the big tradeoff.

Programs to redistribute income are inefficient for threereasons:

1. Income redistribution uses up resources that could have

otherwise been used for producing goods and services.2. Redistribution of income requires taxes to be imposed

and taxes generate a deadweight loss.



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3. Income redistribution decreases the incentives for

Taxpaying workers to provide labor when leisure is anormal good (by decreasing income from work) and

Recipients of income assistance to provide labor andearn an income.

A Major Welfare Challenge

To find ways to assist the poorest identifiable group:Young minority women who have not completed highschool, have dependent children, and live without apartner in the household.



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The long-term solution to their plight is education and jobtrainingacquiring human capital.

The short-term solution is enforcing child support

payments from absent fathers and former husbands, andproviding welfare assistance.

But it must be designed to minimize the disincentive tobecome self-sufficient.



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The Personal Responsibility and Work OpportunitiesReconciliation Act of 1996 increased the penalties fornonpayment of support.

The Act also created the Temporary Assistance for NeedyFamilies (TANF) program.

TANF is a block grant to the states, not an open-endedentitlement program for individuals.

An adult member of a family receiving assistance musteither work or perform community service and there is afive-year limit for receiving assistance.


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