1. Copyright © 2002 by Thomson Learning, Inc. to accompany Exploring Economics 3 rd Edition by Robert L. Sexton Copyright © 2005 Thomson Learning, Inc. Thomson Learning™ is a trademark used herein under license. ALL RIGHTS RESERVED. Instructors of classes adopting EXPLORING ECONOMICS, 3 rd Edition by Robert L. Sexton as an assigned textbook may reproduce material from this publication for classroom use or in a secure electronic network environment that prevents downloading or reproducing the copyrighted material. Otherwise, no part of this work covered by the copyright hereon may be reproduced or used in any form or by any means—graphic, electronic, or mechanical, including, but not limited to, photocopying, recording, taping, Web distribution, information networks, or information storage and retrieval systems—without the written permission of the publisher. Printed in the United States of America ISBN 0-324-26086-5 A Lecture Presentation

2. Copyright © 2002 by Thomson Learning, Inc. Income, Poverty, and Healthcare Chapter 15

3. Copyright © 2002 by Thomson Learning, Inc. 15.1 Income Distribution The ultimate purpose of producing goods and services is to satisfy the material wants of people. The ultimate purpose of producing goods and services is to satisfy the material wants of people. But for whom does society produce consumer goods and services? But for whom does society produce consumer goods and services? Why are some people able to consume much more than others? Why are some people able to consume much more than others?

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5. The Record Since 1935 While there have been changes in the distribution of measured income, there remains substantial income inequality. While there have been changes in the distribution of measured income, there remains substantial income inequality. Inequality might be overstated due to failure to consider differences in Inequality might be overstated due to failure to consider differences in age age certain demographic factors certain demographic factors institutional factors institutional factors and government redistributive activities and government redistributive activities

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7. Are We Overstating the Disparity in the Distribution of Income? At any moment in time, middle-age persons tend to have higher incomes than younger and older persons because At any moment in time, middle-age persons tend to have higher incomes than younger and older persons because they are at an age when their productivity is at a peak they are at an age when their productivity is at a peak they are participating in the labor force to a greater extent they are participating in the labor force to a greater extent

8. Copyright © 2002 by Thomson Learning, Inc. Even if every individual earned exactly the same income over his or her lifetime, there would still be inequality at any given moment in time, so that inequality resulting from this overstates the true inequality in the lifetime earnings of people. Even if every individual earned exactly the same income over his or her lifetime, there would still be inequality at any given moment in time, so that inequality resulting from this overstates the true inequality in the lifetime earnings of people. The increased proportion of Americans that are either very young or very old has tended to increase the observed inequality in the distribution of income. The increased proportion of Americans that are either very young or very old has tended to increase the observed inequality in the distribution of income.

9. Copyright © 2002 by Thomson Learning, Inc. Other demographic trends have also caused the measured distribution of income (measured in terms of household or family income) to appear more unequal. Other demographic trends have also caused the measured distribution of income (measured in terms of household or family income) to appear more unequal. increased number of divorced couples increased number of divorced couples rise of two-income families rise of two-income families DINKS (Double Income, No Kids) DINKS (Double Income, No Kids)

10. Copyright © 2002 by Thomson Learning, Inc. A family that decides to have two bread winners instead of one would move into a higher income quintile and create greater apparent income inequality. A family that decides to have two bread winners instead of one would move into a higher income quintile and create greater apparent income inequality. At the same time, divorces create two households instead of one, lowering income per household for divorced couples; thus, they move into lower income quintiles, also creating greater apparent income inequality. At the same time, divorces create two households instead of one, lowering income per household for divorced couples; thus, they move into lower income quintiles, also creating greater apparent income inequality.

11. Copyright © 2002 by Thomson Learning, Inc. The impact of increased government activity should be considered in evaluating the measured income distribution. The impact of increased government activity should be considered in evaluating the measured income distribution. Government-imposed taxes burden different income groups differently. Government-imposed taxes burden different income groups differently. Also, many government programs benefit some groups of income recipients more than others. Also, many government programs benefit some groups of income recipients more than others.

12. Copyright © 2002 by Thomson Learning, Inc. Food stamps, school lunch programs, housing subsidies, Medicaid, and several other programs provide recipients with in-kind transfers. Food stamps, school lunch programs, housing subsidies, Medicaid, and several other programs provide recipients with in-kind transfers. In-kind transfers are given in the form of goods and services rather than money. In-kind transfers are given in the form of goods and services rather than money.

13. Copyright © 2002 by Thomson Learning, Inc. When taxes and in-kind transfers are included, many economists conclude that they have served to reduce levels of inequality significantly from the levels suggested by aggregate income statistics. When taxes and in-kind transfers are included, many economists conclude that they have served to reduce levels of inequality significantly from the levels suggested by aggregate income statistics.

14. Copyright © 2002 by Thomson Learning, Inc. The evidence suggests that inequality of money income in the United States declined from 1935 to 1950 and then remained rather stable until 1980. The evidence suggests that inequality of money income in the United States declined from 1935 to 1950 and then remained rather stable until 1980. Since then, the distribution of income has become less equal. Since then, the distribution of income has become less equal.

15. Copyright © 2002 by Thomson Learning, Inc. However, if we consider age distribution, institutional factors, and in-kind transfer programs, it is safe to say that the income distribution is considerably more equal than it appears. However, if we consider age distribution, institutional factors, and in-kind transfer programs, it is safe to say that the income distribution is considerably more equal than it appears.

16. Copyright © 2002 by Thomson Learning, Inc. How Much Movement is There on the Economic Ladder? A study of income mobility during the decade of 1985-1995 found that less than 50 percent of individuals who began in the poorest quintile ended up there a decade later, and almost 30 percent of those in the poorest quintile moved up to the top three quintiles. A study of income mobility during the decade of 1985-1995 found that less than 50 percent of individuals who began in the poorest quintile ended up there a decade later, and almost 30 percent of those in the poorest quintile moved up to the top three quintiles.

17. Copyright © 2002 by Thomson Learning, Inc. While the distribution of current income is an important piece of information, it is also critical to know how much movement goes on between different income levels. While the distribution of current income is an important piece of information, it is also critical to know how much movement goes on between different income levels. The people that make up a given income group are not always the same people because there is substantial movement between income groups. The people that make up a given income group are not always the same people because there is substantial movement between income groups.

18. Copyright © 2002 by Thomson Learning, Inc. Most Americans experience significant fluctuations in their economic well-being from one year to the next. Most Americans experience significant fluctuations in their economic well-being from one year to the next. Economic well-being can be affected by changes in personal and family circumstances, such as work experience, marital status, and household composition, as well as changes in earnings. Economic well-being can be affected by changes in personal and family circumstances, such as work experience, marital status, and household composition, as well as changes in earnings.

19. Copyright © 2002 by Thomson Learning, Inc. Why Do Some Earn More Than Others? Age Age Wages generally increase up to the age of 50 and fall dramatically at retirement age. Wages generally increase up to the age of 50 and fall dramatically at retirement age. Younger people tend to make little income when they begin their working careers. Younger people tend to make little income when they begin their working careers. Skill Skill Education and training Education and training Preferences toward risk and leisure Preferences toward risk and leisure

20. Copyright © 2002 by Thomson Learning, Inc. As productivity increases, workers can command higher wages. As productivity increases, workers can command higher wages. Some workers are just more productive than others, as a result of both innate skills and training and education. Some workers are just more productive than others, as a result of both innate skills and training and education. Some workers’ skills are just more in demand than others. Some workers’ skills are just more in demand than others. Those that work longer hours or more intensely earn more. Those that work longer hours or more intensely earn more.

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22. Those who prefer more amenities at work or more time for leisure earn less. Those who prefer more amenities at work or more time for leisure earn less. Those who work in riskier or more unpleasant jobs earn more as compensation. Those who work in riskier or more unpleasant jobs earn more as compensation. Despite difficulties in measurement, international comparisons of income distribution have been made. Despite difficulties in measurement, international comparisons of income distribution have been made.

23. Copyright © 2002 by Thomson Learning, Inc. Income inequality is greater in the United States and United Kingdom than in Sweden and Japan. Income inequality is greater in the United States and United Kingdom than in Sweden and Japan. However, many developed countries have more equal distributions of income than developing countries. However, many developed countries have more equal distributions of income than developing countries. Income Distribution in Other Countries

24. Copyright © 2002 by Thomson Learning, Inc. While income inequality within nations is often substantial, it is far less than income inequality among nations. While income inequality within nations is often substantial, it is far less than income inequality among nations. A majority of income inequality reflects differences in living standards among countries rather than disparities within nations. A majority of income inequality reflects differences in living standards among countries rather than disparities within nations.

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26. 15.2 The Pros and Cons of Income Equality Because of the difficulty of measuring welfare, it is impossible to "prove" that a given income distribution is better than another. Because of the difficulty of measuring welfare, it is impossible to "prove" that a given income distribution is better than another. Political and social changes in the past century or two have generally worked to reduce income inequality. Political and social changes in the past century or two have generally worked to reduce income inequality.

27. Copyright © 2002 by Thomson Learning, Inc. The economic theory that supports income redistribution is derived from the principle of diminishing marginal utility: The economic theory that supports income redistribution is derived from the principle of diminishing marginal utility: where increases in income generate less additional happiness (utility) at higher levels of income where increases in income generate less additional happiness (utility) at higher levels of income Taking from the rich and giving to the poor could increase society's total utility if the rich family loses less utility than the poor family gains from the redistribution. Taking from the rich and giving to the poor could increase society's total utility if the rich family loses less utility than the poor family gains from the redistribution. The Case for Income Redistribution

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29. The theoretical argument favoring income redistribution is based on the assumption that people are alike in how they experience diminishing marginal utility from increasing income, a proposition impossible to prove. The theoretical argument favoring income redistribution is based on the assumption that people are alike in how they experience diminishing marginal utility from increasing income, a proposition impossible to prove. If you believe society should try to equalize happiness among its members, some income redistribution could arguably make sense. If you believe society should try to equalize happiness among its members, some income redistribution could arguably make sense.

30. Copyright © 2002 by Thomson Learning, Inc. The Case Against Income Redistribution The principal disagreement over income redistribution is not over whether we should have some redistribution, but rather over at what point we should stop in our redistributive efforts. The principal disagreement over income redistribution is not over whether we should have some redistribution, but rather over at what point we should stop in our redistributive efforts. Some believe we should go further than we have, while others think we have already gone too far in attempts to alter the distribution of income in favor of the poor and less affluent. Some believe we should go further than we have, while others think we have already gone too far in attempts to alter the distribution of income in favor of the poor and less affluent.

31. Copyright © 2002 by Thomson Learning, Inc. Arguments against a radical redistribution of income to eliminate virtually all inequality include the equity argument: Arguments against a radical redistribution of income to eliminate virtually all inequality include the equity argument: It is not “fair” to take most of the income of hard-working, talented persons who earn high incomes, particularly when some of it is given to persons who perhaps are shiftless and lazy. It is not “fair” to take most of the income of hard-working, talented persons who earn high incomes, particularly when some of it is given to persons who perhaps are shiftless and lazy.

32. Copyright © 2002 by Thomson Learning, Inc. Other arguments against redistribution: Other arguments against redistribution: Some income inequality would seem desirable because consumption needs may well vary with family size, age of family members, and other factors. Some income inequality would seem desirable because consumption needs may well vary with family size, age of family members, and other factors. Radical redistribution would reduce economic growth and future real income. Radical redistribution would reduce economic growth and future real income.

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34. At some point however, increased redistribution of income might create increasing disincentive effects, and reduce the rate of savings, retarding capital formation. At some point however, increased redistribution of income might create increasing disincentive effects, and reduce the rate of savings, retarding capital formation. Ultimately, the cost of more current income equality is less income growth. Ultimately, the cost of more current income equality is less income growth.

35. Copyright © 2002 by Thomson Learning, Inc. 15.3 The Economics of Discrimination Job-entry discrimination Job-entry discrimination A worker is denied employment on the basis of some factor without regard to the productivity of the worker. A worker is denied employment on the basis of some factor without regard to the productivity of the worker. Wage discrimination Wage discrimination Workers are given employment at wages lower than that of other workers on some basis other than productivity differences. Workers are given employment at wages lower than that of other workers on some basis other than productivity differences.

36. Copyright © 2002 by Thomson Learning, Inc. Job Entry Discrimination In a world where sex and race have absolutely no bearing whatsoever on the employment circumstances of persons (e.g. talent, education, willingness and ability to work, move, etc.), every occupation would, apart from random variations, have a workforce with the same sex and race proportions as the population at large. In a world where sex and race have absolutely no bearing whatsoever on the employment circumstances of persons (e.g. talent, education, willingness and ability to work, move, etc.), every occupation would, apart from random variations, have a workforce with the same sex and race proportions as the population at large.

37. Copyright © 2002 by Thomson Learning, Inc. Wage Discrimination A strong statistical correlation exists between lifetime earnings and years of schooling. A strong statistical correlation exists between lifetime earnings and years of schooling. High-school graduates earn roughly two-thirds of the salary of college graduates. High-school graduates earn roughly two-thirds of the salary of college graduates.

38. Copyright © 2002 by Thomson Learning, Inc. While a major reason women and nonwhites earn less than white males is that they occupy jobs that are lower paying, it is possible also that they earn less because of wage discrimination—being paid less for a job strictly because of their race or sex. While a major reason women and nonwhites earn less than white males is that they occupy jobs that are lower paying, it is possible also that they earn less because of wage discrimination—being paid less for a job strictly because of their race or sex.

39. Copyright © 2002 by Thomson Learning, Inc. Discrimination or Differences in Productivity? Merely demonstrating that wages are lower for blacks and females does not in itself prove wage discrimination, although it is consistent with the notion that discrimination occurs. Merely demonstrating that wages are lower for blacks and females does not in itself prove wage discrimination, although it is consistent with the notion that discrimination occurs. If occupational and wage differentials are not caused by discrimination, what are the causes? If occupational and wage differentials are not caused by discrimination, what are the causes?

40. Copyright © 2002 by Thomson Learning, Inc. Several scholars have developed statistical models that argue that a great deal of the earnings differentials across the sexes and races can be explained by differences in productivity. Several scholars have developed statistical models that argue that a great deal of the earnings differentials across the sexes and races can be explained by differences in productivity. Employers hire and pay workers roughly an amount equal to their perceived contributions (marginal revenue product). Employers hire and pay workers roughly an amount equal to their perceived contributions (marginal revenue product).

41. Copyright © 2002 by Thomson Learning, Inc. One explanation for higher productivity among white males than others is that various environmental factors have prevented blacks and women from gaining the training, skills and experience necessary to achieve high productivity. One explanation for higher productivity among white males than others is that various environmental factors have prevented blacks and women from gaining the training, skills and experience necessary to achieve high productivity.

42. Copyright © 2002 by Thomson Learning, Inc. This environmental explanation of productivity differences does not rule out discrimination, but rather argues that past discrimination's perverse influences on the environment of women and nonwhites has caused them to have an inferior endowment of human capital now, even if present-day employers were color- and sex-blind in terms of paying workers. This environmental explanation of productivity differences does not rule out discrimination, but rather argues that past discrimination's perverse influences on the environment of women and nonwhites has caused them to have an inferior endowment of human capital now, even if present-day employers were color- and sex-blind in terms of paying workers.

43. Copyright © 2002 by Thomson Learning, Inc. Why Do People Discriminate? It might appear that discrimination is totally inconsistent with rational utility-maximization. It might appear that discrimination is totally inconsistent with rational utility-maximization. To maximize profits, a firm should minimize costs by hiring the best persons available per dollar of wage expenditure, regardless of the age, sex, race, or other attribute of the worker. To maximize profits, a firm should minimize costs by hiring the best persons available per dollar of wage expenditure, regardless of the age, sex, race, or other attribute of the worker.

44. Copyright © 2002 by Thomson Learning, Inc. To some extent, discrimination may reflect information costs. To some extent, discrimination may reflect information costs. Based on past experience, race or sex may be used as a screening device, to narrow the list of job candidates, because it costs money and time to evaluate the prospects of every applicant. Based on past experience, race or sex may be used as a screening device, to narrow the list of job candidates, because it costs money and time to evaluate the prospects of every applicant.

45. Copyright © 2002 by Thomson Learning, Inc. The information cost reduction from hiring on the basis of color or sex may exceed the perceived benefits from the identification of good workers of a particular color or sex. The information cost reduction from hiring on the basis of color or sex may exceed the perceived benefits from the identification of good workers of a particular color or sex.

46. Copyright © 2002 by Thomson Learning, Inc. It is a fact that some people prefer to associate with persons with certain racial and/or sexual attributes. It is a fact that some people prefer to associate with persons with certain racial and/or sexual attributes. In such cases, the utility gained from having the desired racial or sexual mix might exceed the loss in income from not having the best employees. In such cases, the utility gained from having the desired racial or sexual mix might exceed the loss in income from not having the best employees.

47. Copyright © 2002 by Thomson Learning, Inc. The Costs of Discrimination In competitive industries, firms that discriminate may lose out. In competitive industries, firms that discriminate may lose out. The nondiscriminating firm hires the unfavored but equally competent workers and has a cost advantage, allowing it to undercut discriminating competitors’ prices and either force them out of business or make them change their hiring practices. The nondiscriminating firm hires the unfavored but equally competent workers and has a cost advantage, allowing it to undercut discriminating competitors’ prices and either force them out of business or make them change their hiring practices. In the long run, competition has the potential to reduce discrimination. In the long run, competition has the potential to reduce discrimination.

48. Copyright © 2002 by Thomson Learning, Inc. Remedying Discrimination The primary means used to address economic discrimination in our country is affirmative action programs, in which employers are strongly encouraged to hire more minority group workers in occupations where those groups are now relatively under-represented and to correct wage and salary inequities. The primary means used to address economic discrimination in our country is affirmative action programs, in which employers are strongly encouraged to hire more minority group workers in occupations where those groups are now relatively under-represented and to correct wage and salary inequities.

49. Copyright © 2002 by Thomson Learning, Inc. Some environmental causes of productivity differences have also been attacked. Some environmental causes of productivity differences have also been attacked. There is some evidence that these various efforts have met with some success. There is some evidence that these various efforts have met with some success. Still, the economic differences between different races and sexes are rather large. Still, the economic differences between different races and sexes are rather large.

50. Copyright © 2002 by Thomson Learning, Inc. Affirmative action job hiring programs are controversial. Affirmative action job hiring programs are controversial. The establishment of what are, in effect, quotas on the hiring of minorities increases the probability that some persons will be hired on some basis other than productivity. The establishment of what are, in effect, quotas on the hiring of minorities increases the probability that some persons will be hired on some basis other than productivity.

51. Copyright © 2002 by Thomson Learning, Inc. While this may be desirable from the standpoint of equalizing opportunities between demographic groups, it also can serve to lower the output of society as a whole and profits to firms. While this may be desirable from the standpoint of equalizing opportunities between demographic groups, it also can serve to lower the output of society as a whole and profits to firms. Also, the "reverse discrimination" equity argument is raised. Also, the "reverse discrimination" equity argument is raised.

52. Copyright © 2002 by Thomson Learning, Inc. An alternative approach to one using implicit quotas would be to subsidize employers for hiring minority workers, which would provide employers with greater incentive to increase minority job opportunities. An alternative approach to one using implicit quotas would be to subsidize employers for hiring minority workers, which would provide employers with greater incentive to increase minority job opportunities.

53. Copyright © 2002 by Thomson Learning, Inc. 15.4 Poverty Our concern over income distribution largely arises because of a feeling that people with low incomes (“the poor”) suffer in a material sense relative to other persons. Our concern over income distribution largely arises because of a feeling that people with low incomes (“the poor”) suffer in a material sense relative to other persons.

54. Copyright © 2002 by Thomson Learning, Inc. Defining Poverty The federal government measures poverty by using a set of money income thresholds that vary by family size and are adjusted for inflation. The federal government measures poverty by using a set of money income thresholds that vary by family size and are adjusted for inflation. If the family’s total income is less than the established threshold—the poverty line—it is considered poor. If the family’s total income is less than the established threshold—the poverty line—it is considered poor. The poverty rate is the proportion of persons who fall below that absolute standard. The poverty rate is the proportion of persons who fall below that absolute standard.

55. Copyright © 2002 by Thomson Learning, Inc. The poverty rate for the United States is currently set at three times the cost of providing a nutritionally adequate diet—slightly less than $20,000 for a family of four. The poverty rate for the United States is currently set at three times the cost of providing a nutritionally adequate diet—slightly less than $20,000 for a family of four. The poverty rate may overstate the level of poverty because it does not include noncash benefits, such as public housing, Medicaid, and food stamps. The poverty rate may overstate the level of poverty because it does not include noncash benefits, such as public housing, Medicaid, and food stamps.

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58. With a definition of poverty that is determined at some fixed, real income level, poverty over time should decline and, indeed, largely disappear, unless lower income groups do not share at all in rising incomes because real incomes generally rise over time with economic growth. With a definition of poverty that is determined at some fixed, real income level, poverty over time should decline and, indeed, largely disappear, unless lower income groups do not share at all in rising incomes because real incomes generally rise over time with economic growth.

59. Copyright © 2002 by Thomson Learning, Inc. Thus, one cure for poverty, as defined by some absolute income or standard of living criterion, is economic growth. Thus, one cure for poverty, as defined by some absolute income or standard of living criterion, is economic growth. The greater the rate of economic growth, the more rapidly poverty will be eradicated. The greater the rate of economic growth, the more rapidly poverty will be eradicated.

60. Copyright © 2002 by Thomson Learning, Inc. An Alternative Definition of Poverty Many “poor” individuals in the United States, using the official definition, would be considered well off, even “rich” in many less-developed countries. Many “poor” individuals in the United States, using the official definition, would be considered well off, even “rich” in many less-developed countries. Rather than being classified by an ability to buy some specific basket of goods and services, poverty is often thought of as a relative income concept. Rather than being classified by an ability to buy some specific basket of goods and services, poverty is often thought of as a relative income concept.

61. Copyright © 2002 by Thomson Learning, Inc. A person is poor if his or her income is low relative to the incomes of most other persons in the same geographical area. A person is poor if his or her income is low relative to the incomes of most other persons in the same geographical area.

62. Copyright © 2002 by Thomson Learning, Inc. Using definitions of poverty based on relative income measures, as economic growth proceeds, the income necessary to avoid being considered poor by this measure increases. Using definitions of poverty based on relative income measures, as economic growth proceeds, the income necessary to avoid being considered poor by this measure increases. Using this definition, then, poverty cannot be eradicated by economic growth, but only by income redistribution. Using this definition, then, poverty cannot be eradicated by economic growth, but only by income redistribution.

63. Copyright © 2002 by Thomson Learning, Inc. Income Redistribution There are a variety of programs designed to reduce poverty and redistribute income: There are a variety of programs designed to reduce poverty and redistribute income: Taxes Taxes Transfer Payments Transfer Payments Government Subsidies Government Subsidies Minimum Wage Minimum Wage

64. Copyright © 2002 by Thomson Learning, Inc. One way to redistribute income to reduce disparities among individuals is through federal income tax. One way to redistribute income to reduce disparities among individuals is through federal income tax. The federal income tax is designed to be a progressive tax system— one that imposes higher marginal tax rates on higher incomes. The federal income tax is designed to be a progressive tax system— one that imposes higher marginal tax rates on higher incomes.

65. Copyright © 2002 by Thomson Learning, Inc. A second means by which income redistribution can be carried out by the government is through direct transfer payments to the lower part of the income distribution. A second means by which income redistribution can be carried out by the government is through direct transfer payments to the lower part of the income distribution. Transfer payments are payments made to individuals for which goods or services are exchanged. Transfer payments are payments made to individuals for which goods or services are exchanged.

66. Copyright © 2002 by Thomson Learning, Inc. There are in-kind transfers—direct transfers of goods or services like food stamps, housing subsidies, and Medicaid—and cash transfers like welfare, Social Security, and unemployment compensation. There are in-kind transfers—direct transfers of goods or services like food stamps, housing subsidies, and Medicaid—and cash transfers like welfare, Social Security, and unemployment compensation.

67. Copyright © 2002 by Thomson Learning, Inc. Supplemental Security Income (SSI) is a program designed for the most needy, elderly, disabled, and blind. Supplemental Security Income (SSI) is a program designed for the most needy, elderly, disabled, and blind. Temporary Assistance for Needy Families (TANF) is designed to help families that have few financial resources. Temporary Assistance for Needy Families (TANF) is designed to help families that have few financial resources.

68. Copyright © 2002 by Thomson Learning, Inc. The Earned Income Tax Credit (EITC) is a program that allows the working poor to receive income refunds than can be greater than the taxes they paid during the last year. The Earned Income Tax Credit (EITC) is a program that allows the working poor to receive income refunds than can be greater than the taxes they paid during the last year. It is a means-tested income transfer program like food stamps, Medicaid, and housing subsidies. It is a means-tested income transfer program like food stamps, Medicaid, and housing subsidies.

69. Copyright © 2002 by Thomson Learning, Inc. Government can help the less affluent by using government revenues to provide low-cost public services: Government can help the less affluent by using government revenues to provide low-cost public services: Inexpensive public housing Inexpensive public housing Subsidized public transport Subsidized public transport Public parks Public parks “Free” public education “Free” public education

70. Copyright © 2002 by Thomson Learning, Inc. Federal government subsidies to commuter railroads primarily lower the cost to affluent suburbanites of getting to work in the central city. Federal government subsidies to commuter railroads primarily lower the cost to affluent suburbanites of getting to work in the central city. Support for public universities may help the middle or even upper income groups more than the poor. Support for public universities may help the middle or even upper income groups more than the poor.

71. Copyright © 2002 by Thomson Learning, Inc. There are agricultural subsidies that often provide large benefits to farmers who already have large incomes. There are agricultural subsidies that often provide large benefits to farmers who already have large incomes.

72. Copyright © 2002 by Thomson Learning, Inc. Can a higher minimum wage ease the burden on the poor? Can a higher minimum wage ease the burden on the poor? Almost all economists would agree that a large increase in the minimum wage, to say $20, would have a devastating effect on the unskilled labor market. Almost all economists would agree that a large increase in the minimum wage, to say $20, would have a devastating effect on the unskilled labor market.

73. Copyright © 2002 by Thomson Learning, Inc. There is some debate among economists over the elasticity of the demand curve for labor. There is some debate among economists over the elasticity of the demand curve for labor. If the demand curve for labor is relatively inelastic, an increase in the minimum wage leads to only a small reduction in employment. If the demand curve for labor is relatively inelastic, an increase in the minimum wage leads to only a small reduction in employment.

74. Copyright © 2002 by Thomson Learning, Inc. However, if the demand curve for labor is relatively elastic, the reduction in employment is larger. However, if the demand curve for labor is relatively elastic, the reduction in employment is larger. Critics of a higher minimum wage argue that it is poorly targeted, if its object is to reduce poverty, because many of the recipients of the minimum wage are teenagers living in households that are not facing poverty. Critics of a higher minimum wage argue that it is poorly targeted, if its object is to reduce poverty, because many of the recipients of the minimum wage are teenagers living in households that are not facing poverty.

75. Copyright © 2002 by Thomson Learning, Inc. Some argue that a policy focusing on subsidizing the wages of the poor would go a lot further in reducing poverty. Some argue that a policy focusing on subsidizing the wages of the poor would go a lot further in reducing poverty. That is, society needs to find more effective policy for low-wage workers—perhaps job training programs. That is, society needs to find more effective policy for low-wage workers—perhaps job training programs.

76. Copyright © 2002 by Thomson Learning, Inc. 15.5 Healthcare Like the production of any other good or service, however, healthcare involves the utilization of scarce resources. Like the production of any other good or service, however, healthcare involves the utilization of scarce resources. Not only must the healthcare sector compete with other sectors for resources, but those resources must be allocated across patients facing vastly different circumstances. Not only must the healthcare sector compete with other sectors for resources, but those resources must be allocated across patients facing vastly different circumstances.

77. Copyright © 2002 by Thomson Learning, Inc. The Rising Cost of Healthcare The United States spends more money on healthcare per person and as a percentage of national income than any other industrialized nation. The United States spends more money on healthcare per person and as a percentage of national income than any other industrialized nation. In 2001, healthcare expenditures comprised approximately 14 percent of GDP. In 2001, healthcare expenditures comprised approximately 14 percent of GDP.

78. Copyright © 2002 by Thomson Learning, Inc. Spending on healthcare has increased significantly over the last several decades, averaging over 14 percent of GDP throughout the 1990s compared with only 5.1 percent in 1960. Spending on healthcare has increased significantly over the last several decades, averaging over 14 percent of GDP throughout the 1990s compared with only 5.1 percent in 1960.

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82. The utilization of medical care involves trade-offs. The utilization of medical care involves trade-offs. Scarce resources allocated toward the production of health services cannot be used in the production of other goods and services. Scarce resources allocated toward the production of health services cannot be used in the production of other goods and services.

83. Copyright © 2002 by Thomson Learning, Inc. Investment in healthcare bears similarities to investment in human or physical capital. Investment in healthcare bears similarities to investment in human or physical capital. By promoting health and removing disabilities, medical care can By promoting health and removing disabilities, medical care can improve the productivity of workers on the job and reduce missed workdays improve the productivity of workers on the job and reduce missed workdays extend the average number of years of participation by people in the labor force extend the average number of years of participation by people in the labor force

84. Copyright © 2002 by Thomson Learning, Inc. The Demand for Healthcare Increases in the quality and quantity of labor available due to better healthcare will shift an economy’s production possibilities curve outward. Increases in the quality and quantity of labor available due to better healthcare will shift an economy’s production possibilities curve outward. Both the demand for and supply of healthcare have increased over the last several decades. Both the demand for and supply of healthcare have increased over the last several decades.

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86. Income Estimates of the price elasticity of demand for healthcare generally range between 0.2 and 1.0, indicating significant inelasticity of demand for medical services. Estimates of the price elasticity of demand for healthcare generally range between 0.2 and 1.0, indicating significant inelasticity of demand for medical services. The quantity of medical care demanded appears to be quite insensitive to changes in price. The quantity of medical care demanded appears to be quite insensitive to changes in price.

87. Copyright © 2002 by Thomson Learning, Inc. Healthcare is considered a necessity with few good substitutes, particularly when it comes to serious illness. Healthcare is considered a necessity with few good substitutes, particularly when it comes to serious illness.

88. Copyright © 2002 by Thomson Learning, Inc. Insurance The health services market differs from many others in that, due to insurance, the consumer often pays only a fraction of the direct cost of care. The health services market differs from many others in that, due to insurance, the consumer often pays only a fraction of the direct cost of care. Third-party payers, such as insurance companies or health maintenance organizations, play significant roles in this industry, which have important incentive effects and alter the behavior of both patients and providers. Third-party payers, such as insurance companies or health maintenance organizations, play significant roles in this industry, which have important incentive effects and alter the behavior of both patients and providers.

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91. In addition to increasing the quantity of healthcare demanded by reducing price, insurance alters the incentive of patients in other ways. In addition to increasing the quantity of healthcare demanded by reducing price, insurance alters the incentive of patients in other ways. Insurance reduces the cost to the insured of undertaking risky activities. Insurance reduces the cost to the insured of undertaking risky activities. In an accident or illness, the healthcare costs are borne by the insurer. In an accident or illness, the healthcare costs are borne by the insurer. This creates what economists call a “moral hazard” problem. This creates what economists call a “moral hazard” problem.

92. Copyright © 2002 by Thomson Learning, Inc. Moral hazard in healthcare exists whenever insurance makes a person more likely to engage in risky behavior (which could lead to an accident or illness) and less likely to undertake preventative measures against illness. Moral hazard in healthcare exists whenever insurance makes a person more likely to engage in risky behavior (which could lead to an accident or illness) and less likely to undertake preventative measures against illness.

93. Copyright © 2002 by Thomson Learning, Inc. Insurance companies or third-party payers attempt to reduce moral hazard problems by requiring patients to pay higher deductibles and/or co-payments, thereby compelling the insured to share a greater proportion of incurred costs. Insurance companies or third-party payers attempt to reduce moral hazard problems by requiring patients to pay higher deductibles and/or co-payments, thereby compelling the insured to share a greater proportion of incurred costs.

94. Copyright © 2002 by Thomson Learning, Inc. Insurance may pose additional problems for the healthcare industry. Insurance may pose additional problems for the healthcare industry. A situation of asymmetric information exists whenever patients know more about their own health status than prospective insurers. A situation of asymmetric information exists whenever patients know more about their own health status than prospective insurers. This is known as "adverse selection" because the chronically ill are more likely to demand health insurance than are those in good health. This is known as "adverse selection" because the chronically ill are more likely to demand health insurance than are those in good health.

95. Copyright © 2002 by Thomson Learning, Inc. An insurance company inviting voluntary participation in a plan may find that it has insured an adverse selection of largely ill patients and would be forced to increase insurance premiums to stave off losses. An insurance company inviting voluntary participation in a plan may find that it has insured an adverse selection of largely ill patients and would be forced to increase insurance premiums to stave off losses.

96. Copyright © 2002 by Thomson Learning, Inc. As insurance premiums increase, however, healthy enrollees are more likely to drop out of the plan (opting instead for cheaper, less generous health insurance plans or for self- insurance). As insurance premiums increase, however, healthy enrollees are more likely to drop out of the plan (opting instead for cheaper, less generous health insurance plans or for self- insurance). This further exacerbates the adverse selection problem. This further exacerbates the adverse selection problem.

97. Copyright © 2002 by Thomson Learning, Inc. Insurers can reduce adverse selection risk by Insurers can reduce adverse selection risk by limiting the period of open enrollment in health insurance plans limiting the period of open enrollment in health insurance plans requiring physical exams (so that an individual cannot purchase insurance after serious illness strikes) requiring physical exams (so that an individual cannot purchase insurance after serious illness strikes) insuring entire groups (such as all members of a large employer or union) in order to ensure a diversity of health statuses insuring entire groups (such as all members of a large employer or union) in order to ensure a diversity of health statuses

98. Copyright © 2002 by Thomson Learning, Inc. Demographic Changes The aging of the U.S. population is an additional factor that explains the increase in demand for healthcare. The aging of the U.S. population is an additional factor that explains the increase in demand for healthcare. The elderly consume a disproportionate share of healthcare services (three to four times as much as the rest of the population). The elderly consume a disproportionate share of healthcare services (three to four times as much as the rest of the population).

99. Copyright © 2002 by Thomson Learning, Inc. The Supply of Healthcare The supply of healthcare has increased slowly since 1960. The supply of healthcare has increased slowly since 1960. The number of providers has increased but has not kept up with the demand for medical services. The number of providers has increased but has not kept up with the demand for medical services. There has been an increase in the cost of medical education and training as well as a greater use of high-cost technological equipment in the healthcare industry. There has been an increase in the cost of medical education and training as well as a greater use of high-cost technological equipment in the healthcare industry.

100. Copyright © 2002 by Thomson Learning, Inc. Doctors as Gatekeepers Healthcare services may be provided through Healthcare services may be provided through independent physicians independent physicians nonprofit hospitals nonprofit hospitals for-profit hospitals for-profit hospitals health maintenance organizations health maintenance organizations preferred provider organizations preferred provider organizations nursing homes nursing homes hospices hospices home health providers home health providers other healthcare agents and agencies other healthcare agents and agencies

101. Copyright © 2002 by Thomson Learning, Inc. Traditional health insurance in the United Sates provides indemnity coverage (security in the event of illness or injury) on a fee-for-service basis. Traditional health insurance in the United Sates provides indemnity coverage (security in the event of illness or injury) on a fee-for-service basis.

102. Copyright © 2002 by Thomson Learning, Inc. Escalating healthcare costs over the last decade, however, have led to a greater emphasis on cost containment. Escalating healthcare costs over the last decade, however, have led to a greater emphasis on cost containment. There has been a proliferation of organizations offering managed care, including health maintenance organizations and preferred provider organizations. There has been a proliferation of organizations offering managed care, including health maintenance organizations and preferred provider organizations.

103. Copyright © 2002 by Thomson Learning, Inc. Health maintenance organizations (HMOs) combine tow traditionally separated functions: the provision of comprehensive healthcare and its financing. Health maintenance organizations (HMOs) combine tow traditionally separated functions: the provision of comprehensive healthcare and its financing.

104. Copyright © 2002 by Thomson Learning, Inc. A preferred provider organization (PPO) is a network of doctors who agree to provide services to a health plan’s enrollees at discounted fees. A preferred provider organization (PPO) is a network of doctors who agree to provide services to a health plan’s enrollees at discounted fees.

105. Copyright © 2002 by Thomson Learning, Inc. Technological Progress and Quality of Care Medical research and technological progress has vastly improved the quality of medical care. Medical research and technological progress has vastly improved the quality of medical care. Innovative therapies help reduce disability, improve health, and prolong life. Innovative therapies help reduce disability, improve health, and prolong life. Some innovations undoubtedly reduce the overall cost of healthcare. Some innovations undoubtedly reduce the overall cost of healthcare. Other innovations, however, significantly add to the cost of healthcare. Other innovations, however, significantly add to the cost of healthcare.

106. Copyright © 2002 by Thomson Learning, Inc. Technological advances have led not only to an increase in the supply of healthcare, but through its interaction with insurance, also a significant increase in the demand for medical care. Technological advances have led not only to an increase in the supply of healthcare, but through its interaction with insurance, also a significant increase in the demand for medical care. Insured patients who bear a small fraction of healthcare costs naturally desire the best possible care, contributing to a rise in healthcare costs that far exceeds the average level of inflation. Insured patients who bear a small fraction of healthcare costs naturally desire the best possible care, contributing to a rise in healthcare costs that far exceeds the average level of inflation.

107. Copyright © 2002 by Thomson Learning, Inc. Imperfect Competition Healthcare markets are imperfectly competitive for several reasons, including Healthcare markets are imperfectly competitive for several reasons, including the presence of legal or administrative barriers to entry the presence of legal or administrative barriers to entry economies of scale economies of scale collusion collusion restrictions on advertising restrictions on advertising

108. Copyright © 2002 by Thomson Learning, Inc. Compulsory licensing Compulsory licensing Restricts entry into the healthcare market. Restricts entry into the healthcare market. Licensing requirements and limitations on hospital privileges are justified as protecting patients from inferior-quality medical care by certifying that physicians possess a certain level of competency. Licensing requirements and limitations on hospital privileges are justified as protecting patients from inferior-quality medical care by certifying that physicians possess a certain level of competency. Restricting the supply of physicians, licensing and hospital privilege requirements limit the quantity of services provided and lead to higher medical prices. Restricting the supply of physicians, licensing and hospital privilege requirements limit the quantity of services provided and lead to higher medical prices.

109. Copyright © 2002 by Thomson Learning, Inc. Healthcare economies of scale Healthcare economies of scale Specialty services may be utilized infrequently requiring large populations be served by only a few providers. Specialty services may be utilized infrequently requiring large populations be served by only a few providers. Cities and towns are often unable to support a large number of hospitals. Cities and towns are often unable to support a large number of hospitals. Only in densely populated metropolitan areas may it be economical for numerous hospitals to compete. Only in densely populated metropolitan areas may it be economical for numerous hospitals to compete. Conditions may be such that "natural monopolies" exist in many areas. Conditions may be such that "natural monopolies" exist in many areas.

110. Copyright © 2002 by Thomson Learning, Inc. Healthcare providers possess significant market power, making price discrimination and collusive behavior (such as price-fixing) more likely to occur. Healthcare providers possess significant market power, making price discrimination and collusive behavior (such as price-fixing) more likely to occur.

111. Copyright © 2002 by Thomson Learning, Inc. Shortages In Canada, where a national healthcare program controls prices and strictly rations care, conditions of excess demand for surgery prevail. In Canada, where a national healthcare program controls prices and strictly rations care, conditions of excess demand for surgery prevail. Likewise, shortages prevail in the market for organ transplants. Likewise, shortages prevail in the market for organ transplants.

112. Copyright © 2002 by Thomson Learning, Inc.