McGraw-Hill/Irwin Chapter 11: Income Inequality and Poverty Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved

Measures of Income Inequality LO: 11-1 To measure income inequality, one can study  Distribution (percentage of households) by income category  Distribution of income across quantiles (five groups with equal number of people in each, ordered by income)  Lorenz Curve and Gini Ratio:  Lorenz Curve plots cumulative percentage of income receivers vs. cumulative percentage of their income.  Gini ratio is a numerical measure of the overall dispersion of income. Income inequality is the unequal distribution of an economy’s total income among households or families. 11-2

(1) Quintile (2) Percentage of Total Income Lowest 20% Second 20% Third 20% Fourth 20% Highest 20% Total Distribution by Quintiles Source: Bureau of the Census (3) Upper Income Limit $20,035 37,774 60,000 97,032 No Limit U.S. Income Inequality in 2006: Quintiles LO:

Perfect Equality Lorenz Curve (Actual Distribution) Complete Inequality A B a b c d e f Gini Ratio = = 0.47 Area A Area A + Area B Percentage of Households Percentage of Income U.S. Income Inequality in 2006: Lorenz Curve and Gini Ratio LO:

Income Mobility  Over some period of time, income receivers move from one part of the income distribution to another. This is called income mobility.  For most income receivers, income starts out relatively low, reaches a peak during middle age and then declines.  For many, “low income” and “high income” are not permanent conditions. LO:

Lorenz Curve Before Taxes and Transfers Percentage of Households Percentage of Income Lorenz Curve After Taxes and Transfers Impact of Government Taxes and Transfers LO:

Causes of Income Inequality  Ability: mental, physical, and aesthetic talents differ across people.  Education and Training: Individuals differ significantly in the amount of education and training (including on-the-job training).  Discrimination in education, hiring, training, and promotion.  Preferences for market work relative to leisure, market work relative to work in the household, and types of occupations.  People differ in their willingness to assume Risk.  Unequal Distribution of Wealth generates inequality in income.  Market Power in labor and product markets generate inequality.  Luck, Connections, and Misfortune contribute to inequality. LO:

Income Inequality over Time  In the U.S. inequality has been rising since  Causes of growing inequality:  Greater demand for highly skilled workers  Demographic changes  International trade  Immigration  Decline in unionism LO:

Equality vs. Efficiency The Case for Equality: Maximizing Total Utility An equal distribution of income maximizes the total consumer satisfaction (or utility) for any particular level of output and income. The Case for Inequality: Incentives and Efficiency Income distribution is important in determining the amount of output or income that is produced and available for distribution. LO:

Anderson’s Marginal Utility From Income Brooks’ Marginal Utility From Income 00 Marginal Utility Income $5000 $2500 $7500 MU B MU A a a’ b’ b Utility Gain (Entire Blue Area) Utility Loss (Entire Red Area) The Utility-Maximizing Distribution of Income LO:

Equality-Efficiency Tradeoff  The equality-efficiency tradeoff is the decrease in economic efficiency that may accompany an increase in income equality.  Greater income equality (achieved through income redistribution) comes at the opportunity cost of reduced production and income.  Greater production and income comes at the expense of higher income inequality. LO:

Poverty in the U.S.  Poverty in the U.S. is measured by the poverty rate, the percentage of population living in poverty.  In 2006 the poverty rate in the U.S. was 12.3 percent.  Poverty rate varies across population groups.  Since the 1970s the poverty rate was stable. Poverty rate is the percentage of the population with income below the official poverty income levels established by the Federal government. LO: 11-5 Poverty is a condition in which a person or family does not have the means to satisfy basic needs for food, clothing, shelter, and transportation

2006 U.S. Definition and Incidence of Poverty LO: 11-5 Female-Householders African-Americans Hispanics Foreign-Born (Not Citizens) Children Under 18 Women Total Population Asians Whites Men Persons 65 or Older Married-Couple Families Full-Time Workers percent Definition of poverty Single person < $9,800 Family of 4 < $20,000 Family of 6 < $26,

Income-Maintenance Programs  A widely accepted goal of U.S. public policy is to help those who have very low income.  Income-maintenance programs are designed to reduce poverty and consists of two kinds of entitlement programs:  social insurance  public assistance LO: 11-6 Entitlement programs are government programs that guarantee particular levels of transfer payments or noncash benefits to all who fit the programs’ criteria

Income-Maintenance Programs Social insurance  Social Security  Medicare  Unemployment compensation Public assistance  Supplemental Security Income (SSI)  Temporary Assistance for Needy Families (TANF)  Food stamps  Medicaid  Earned-income tax credit (EITC) LO: