chapter 18 income distribution and poverty gottheil — principles of economics, 7e © 2013 cengage...

Chapter 18Chapter 18

INCOME DISTRIBUTION INCOME DISTRIBUTION AND POVERTYAND POVERTY

Gottheil — Principles of Economics, 7e© 2013 Cengage Learning1

Economic PrinciplesEconomic Principles

© 2013 Cengage Learning Gottheil — Principles of Economics, 7e2

The Lorenz curve

The Gini coefficient

Rawls’s theory of justice

Life cycle wealth

The case for income equality

Economic PrinciplesEconomic Principles


The case for income inequality

Poverty thresholds

Negative income tax

Income Distribution and PovertyIncome Distribution and Poverty


Questions about the rich and the poor arise from the political, ethical, economic and religious foundations of our society.



Questions include:• Why are some people rich and others poor?

• Why does it seem there are so many more poor than rich?

• Can anything be done about the situation?



These questions concerning income distribution haven’t changed much in the last 2,500 years.



There is one difference, however. Today, it is commonly recognized that a person’s income seems to be connected to that person’s productive contribution in the market.

Not Too Many Coal Miners Are Not Too Many Coal Miners Are MillionairesMillionaires


There are four forms of income:

• Wages

• Interest

• Rent

• Profit



One can generally guess a person’s economic status by knowing the principal source of the person’s income.



When there is a shift in either the supply curves or MRP curves of labor, capital, or land, the equilibrium wage rates, interest rates, and rents also change.



People’s income increases or decreases as a result of these changes.

Measuring Income DistributionMeasuring Income Distribution


There are two principal ways to measure an economy’s income distribution:• The Lorenz curve

• The Gini coefficient



Lorenz curve

• A curve depicting an economy’s income distribution. It records the percentage of total income that a specific part of the population—typically represented by quintiles, ranging from the poorest to the richest—receives.



Lorenz curve

• The percentage of population is measured along the horizontal axis and the percentage of total income is measured along the vertical axis.



Perfect income equality is achieved when each percent of the population receives an equal percent of the economy’s total income. The perfect income equality curve on the Lorenz curve is a diagonal.



For example, if 20 percent of the people receive 20 percent of the income, then there is perfect income equality.



Perfect income inequality is achieved when one person receives all of the income and everyone else receives no income. The prefect income inequality curve on a Lorenz curve is formed by the two sides of a right angle.



In reality all income distributions lie somewhere between perfect equality and perfect inequality.

© 2013 Cengage Learning19

EXHIBIT 1LORENZ CURVES FOR THE COM- MUNITIES OF WASHTENAU, SPRINGFIELD, AND HOLMES

Gottheil — Principles of Economics, 7e

Exhibit 1: Lorenz Curves for the Exhibit 1: Lorenz Curves for the Communities of Washtenau, Communities of Washtenau,

Springfield, and HolmesSpringfield, and Holmes


What percentage of total income do the poorest 20 percent of the population receive in Washtenau, Springfield and Holmes? • They receive 20 percent of total income in

Washtenau, 0 percent in Springfield and 4 percent in Holmes.


EXHIBIT 2 LORENZ CURVES FOR SWEDEN, CHINA, BRAZIL, AND THE UNITED STATES


Exhibit 2: Lorenz Curves for Exhibit 2: Lorenz Curves for Sweden, China, Brazil and the Sweden, China, Brazil and the

United StatesUnited States


Which country in Exhibit 2 has the greatest income equality? The least? • Sweden has the greatest income equality,

while Brazil has the least.



• The Lorenz curve is not perfect and is, at best, only a rough estimate of the underlying reality.

• For example, the distribution of government-provided goods such as national security, health care and transportation are impossible to account for in the Lorenz curve.



• Consider the champagne glass effect to explain world income distribution, divide the height of the glass (see Exhibit 3) into five segments or quintiles.

• The top and widest contains the income held by the richest—75 percent of the world’s income.


EXHIBIT 3 WORLD INCOME DISTRIBUTION ANDREGIONAL SHARES

Source: Dikhanov 2005.


Exhibit 3: World Income Distribution Exhibit 3: World Income Distribution and Regional Sharesand Regional Shares


What does this exhibit prove about world income inequities?• World income disparity between top and

bottom is great.

• By region, the distribution of world income is skewed in favor of the high-income OECD.



Gini coefficient

• A numerical measure of the degree of income inequality in an economy. It ranges from zero, depicting perfect equality, to one, depicting perfect inequality.



The coefficient is a ratio of the two areas produced by the Lorenz curve. Area A lies between the diagonal and the economy’s Lorenz curve. Area B lies below the economy’s Lorenz curve.



The coefficient (G) is calculated asG = A/(A + B).


EXHIBIT 4 THE GINI COEFFICIENT

Exhibit 4: The Gini CoefficientExhibit 4: The Gini Coefficient


As the area represented by A in Exhibit 3 becomes smaller, the Gini coefficient becomes:i. Smaller

ii. Larger

How Unequal is Our Income How Unequal is Our Income Distribution?Distribution?


An overall upward drift toward greater income inequality shows up in the Lorenz curve and Gini coefficient between 1970 and 2006 in the United States.


EXHIBIT 5 SHARE OF AGGREGATE INCOME RECEIVED BY HOUSEHOLDS, BY QUINTILE AND TOP 5 PERCENT, AND GINI COEFFICIENT: 1970–2006

Source: U.S. Bureau of the Census, Money Income in the United States: 1995, Current Population Reports, P60–193 (Washington, D.C.: U.S. Government Printing Office, 1996); U.S. Bureau of the Census, Money Income in the United States: 1999, Current Population Reports, P60–220 (Washington, D.C.: U.S. Government Printing Office, 2001); U.S. Census Bureau, Housing and Household Economic Statistics, August 2007..

Exhibit 5: Share of Aggregate Income Exhibit 5: Share of Aggregate Income Received by Households, by Quantile Received by Households, by Quantile

and Top 5 Percent, and Gini and Top 5 Percent, and Gini Coefficient: 1970–2006Coefficient: 1970–2006


How has the share of total income received by the top 5 percent changed in the U.S. since 1970?• The top 5 percent received about 16 percent

of the total income in 1970. By 2006, it had increased to over 22 percent.


EXHIBIT 5 GINI COEFFICIENT FOR HOUSEHOLDS, BYRACE AND ETHNIC ORIGIN, 1970–2004

Source: U.S. Bureau of the Census, Housing and Household Economic Statistic Division, December 20, 2005.

Exhibit 5: Gini Coefficient for Exhibit 5: Gini Coefficient for Households, by Race and Ethnic Households, by Race and Ethnic

Origin, 1970–2004Origin, 1970–2004


This table shows what pattern in the Gini coefficients within white, black, Asian, and Hispanic households?• The pattern that income inequality grew

within each racial or ethnic category?

How Unequal Is Our Income How Unequal Is Our Income Distribution?Distribution?


The increase in income inequality seen in the U.S. is similar to the pattern in some developed countries, while other developed countries seem to be more egalitarian.

How Unequal Is Our Income How Unequal Is Our Income Distribution?Distribution?


In developing countries, income inequality is extreme. Many economists attribute the inequality to their agrarian economies. The prospect for breaking out depends on the creation of nonagricultural employment.


EXHIBIT 6 GINI COEFFICIENTS FOR EUROPE, JAPAN,CANADA, AND AUSTRALIA (2005)

Source: Human Development Report 2007–2008, United Nations Development Programme, 2008..

Exhibit 6: Gini Coefficients for Exhibit 6: Gini Coefficients for Europe, Japan, Canada, and Europe, Japan, Canada, and

Australia (2005Australia (2005))


How does U.S. income distribution compare to that of other economies?• U.S. income distribution is not only less

equitable than in Europe, Canada, Japan, and Australia.


EXHIBIT 7 INEQUALITY IN THE U.S. AND SELECTEDEUROPEAN COUNTRIES, 1980–2005

Source: Standing Alone in Inequality, Bernard Waskow, The Century Foundation, in http://www.tcf.org/list.asp?type=NC&publid=1403.

Exhibit 7: Inequality in the U.S. Exhibit 7: Inequality in the U.S. and Selected European and Selected European Countries 1980–2005Countries 1980–2005


By comparing U.S. income distribution to this selection of European countries, what do you see?• Their Gini differences seem to be widening

as well.


EXHIBIT 8 WORLD MAP OF GINI COEFFICIENTS

Source: UN Human Development Report 2007/2008.

Exhibit 8: World Map of Gini Exhibit 8: World Map of Gini CoefficientsCoefficients


Where can we see more dramatic differences among world income distribution patterns?• The distributions for most of the developing

economies of Asia, Africa, the Middle East, and Latin America as shown in Exhibit 8.

How Unequal Is Our Income How Unequal Is Our Income Distribution? Distribution?


Wealth

• The accumulated assets owned by individuals.



Life-cycle wealth

• Wealth in the form of nonmonetary assets, such as a house, automobiles, and clothing.



• Wealth represents the accumulated assets of a lifetime, including inherited assets.

• Wealth tends to be far more unevenly distributed than income.

Is There an Optimal Income Is There an Optimal Income Distribution? The Case for Equality Distribution? The Case for Equality


Some argue that good fortune, as well as disaster, are distributed randomly. Income inequality, then, has no more justification than a lottery result.



Harvard philosopher John Rawls agrees. He believes that people who look at income distribution alternatives objectively, would always choose less income inequality.



Others, particularly Marxists, argue for income equality based on the idea that people are created equally. They believe that individuals come to own property by theft. The unequal distribution of property creates income inequality.



Still others, particularly economist A.P. Lerner, make the case for equality based on the presumption that equality produces the greatest welfare for the greatest number of people.


EXHIBIT 9 EQUALITY AND MAXIMUM UTILITY

Exhibit 9: Equality and Exhibit 9: Equality and Maximum Utility Maximum Utility


Where is combined total utility maximized in Exhibit 9? • Combined total utility is maximized at equality

—when each person has $10.

Is There an Optimal Income Is There an Optimal Income Distribution? The Case for Inequality Distribution? The Case for Inequality


Other economists argue for income inequality by drawing on the connection between productive contribution and economic reward.



The argument is that without the reward linkage, productive people would lack the incentive to contribute as much as they do. The economy’s output would be less than its productive potential.



Even though total national income may fall as a result of redistributing wealth toward greater equality, how-ever, the poor may still be better off.


EXHIBIT 10 EFFECT OF INEQUALITY ON NATIONAL INCOME

Exhibit 10: Effect of Inequality Exhibit 10: Effect of Inequality on National Income on National Income


1. How does national income change as the Gini coefficient moves from 0.45 to 0.35?• National income declines from $900 billion to

$700 billion as the Gini coefficient declines.

Exhibit 10: Effect of Inequality Exhibit 10: Effect of Inequality on National Income on National Income


2. How does the income received by the poorest 60 percent change?

• Although national income declines, the income received by the poorest 60 percent increases from $300 billion to $350 billion.



Income inequality may also lead to economic growth. The rich tend to do the country’s investing. The richer the rich, the greater the investment and the higher the rate of growth.



The poor may even benefit from the inequality. Even though their share of national income is relatively small, as investments grow and the economy grows, the absolute size of their share will increase.


EXHIBIT 11 INEQUALITY AND ECONOMIC GROWTH

Exhibit 11: Inequality and Exhibit 11: Inequality and Economic Growth Economic Growth


What happens to the income received by the poorest 60 percent after 15 years in Exhibit 11?• After 15 years, the income received by the

poorest 60 percent in the more unequal society (G = 0.45) surpasses that of the more equal society (G = 0.35).

Do We Have to Live with Poverty? Do We Have to Live with Poverty?


To many people, poverty is a relative concept. People are only poor relative to others. How many live in poverty, then, depends not on a person’s particular income, but upon the relationship between that income and the income of others.



Median income

• The midpoint of a society’s income distribution, above and below which an equal number of individuals (or families) belong.



Poverty threshold

• The level of income below which families are considered to be poor.



Another way of identifying poverty is by describing some minimal acceptable physical standard of living that people ought to have.


EXHIBIT 12 PERCENTAGE OF PERSONS BELOW THE POVERTY LEVEL, BY RACE, 1960–2005

NA = not available* Refers to data for 1959Source: Bureau of the Census, Statistical Abstract of the United States, 2008 (Washington, D.C.; Department of Commerce, 2008), p. 459..

Exhibit 12: Percentage of Exhibit 12: Percentage of Persons Below the Poverty Persons Below the Poverty Level, by Race, 1960–2005 Level, by Race, 1960–2005


How has the number of people living in poverty changed since 1960?• Between 1960 and 1970 the number of people

living in poverty dropped dramatically from over 22 percent to about 12 percent. It has held fairly steady since then.

Fighting the War on Poverty Fighting the War on Poverty


Cash assistance

• Government assistance in the form of cash.

Fighting the War on Poverty Fighting the War on Poverty


In-kind assistance

• Government assistance in the form of direct goods and services, such as Medicaid or food stamps.


EXHIBIT 13 CASH AND NONCASH BENEFITS FOR PERSONS OF LIMITED INCOME: 2005

Source: Statistical Abstract of the United States, 2008 (Washington, D.C.: Department of Commerce, 2008, p. 309.

Exhibit 13: Cash and Noncash Exhibit 13: Cash and Noncash Benefits for Persons with Benefits for Persons with

Limited Income: 2005 Limited Income: 2005


What types of programs for the poor has the government funded?• Medical care, food, housing, education, job

training, energy assistance and cash aid are all programs supported by the government.

The Negative Income Tax The Negative Income Tax Alternative Alternative


Negative income tax

• Government cash payments to the poor—an income tax in reverse—that is linked to the income levels of the poor. The cash payments decrease as income levels increase. The payments are designed to provide a minimum level of income to the poor.

The Negative Income Tax The Negative Income Tax Alternative Alternative


Under this scheme, the poor are provided with enough money to maintain a minimum standard of living and are allowed to earn as much as possible without penalty. It creates an incentive to work.


EXHIBIT 14 THE NEGATIVE INCOME TAX APPLIED (TAX = 50%)

Exhibit 14: The Negative Income Tax Exhibit 14: The Negative Income Tax Applied (Tax = 50%) Applied (Tax = 50%)


If the government sets a minimum income level of $10,000 and incomes are taxed at 50 percent, what would be the after-tax income of a family earning $10,000?• The family’s tax obligation would be ($10,000

× 50%) = $5,000.



If the government sets a minimum income level of $10,000 and incomes are taxed at 50 percent, what would be the after-tax income of a family earning $10,000?• This leaves an after-tax income independently

derived of $5,000.



If the government sets a minimum income level of $10,000 and incomes are taxed at 50 percent, what would be the after-tax income of a family earning $10,000?• The family still receives the $10,000 negative

income tax, so total after-tax income is $15,000.

chapter 18 income distribution and poverty gottheil — principles of economics, 7e © 2013 cengage...

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