Ch. 18: Economic Inequality Measuring inequality Inequality in income versus wealth Sources of inequality Income redistribution by government.

Measuring Economic Inequality Market income wages, interest, rent, and profit earned by the household in factor markets, before paying income taxes. Money income: market income plus cash payments to households by the government.

Measuring Economic Inequality The distribution of income in the United States is positively skewed (i.e. the mean exceeds the median)

Measuring Economic Inequality The distribution of income shares for the United States in 2001.

Lorenz Curve & Gini L-curve shows the cumulative distribution of income. L-curve if one household had 100% of the income? Gini = x/(x+y) Gini perfect equality? perfect inequality?

Wealth Versus Income The distribution of wealth is even more unequally distributed than income. Wealth Gini vs. Income Gini?

Wealth Versus Income Wealth is a stock of assets and income is a flow of earnings that result from a given stock of wealth. Why is wealth distributed less equally than income? Wealth measures don’t include value of human capital. Young will have low earnings, but may have significant amounts of human capital. Middle aged have accumulated wealth and are in their peak years for labor earnings. Elderly will be decumulating wealth and have low labor earnings.

Trends in Inequality

Measuring Economic Inequality I’ve left this figure as a manual animation. You might want to spend a minute or two talking about each characteristic as you build the figure. Note that region makes almost no difference. The data are for 2000, but the patterns don’t change much from year to year. Point out that those characteristics that have the greatest influence over household income (level of education, size of household, marital status) result from choices and not characteristics outside the individual’s control (age or race). Emphasize that not all who are living in the lowest (or highest) income quintile will remain in that same economic situation in the long term. Emphasize that private enterprise democracies create dynamic socio-economic pathways for their citizens.

Poverty A situation in which a household’s income is too low to be able to buy the quantities of food, shelter, and clothing that are deemed “necessary”. In 2000: the poverty level calculated by the Social Security Administration for a four-person family was $17,761. 11.3 percent of the total population was in poverty. 9.4 percent of white households 21.7 percent of Hispanic households 31.3 percent of black households lived in poverty

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

Sources of Economic Inequality The difference in equilibrium wages for high-skilled versus low-skilled labor is the result of Higher demand for high skilled (MRP) Less supply of high skilled at any given wage (compensating difference)

Sources of Rising Inequality Demand for low skill labor has fallen relative to high skill Technological change Trade Immigration?

Sources of Rising Inequality The demand for high-skilled labor has increased and the wage rate has risen.

Sources of Economic Inequality Discrimination Occurs if two equally productive workers are paid different wages. Economic studies reveal that differences in human capital alone do not explain gender or race-differences in income. Sources of discrimination: Employer Employee Customer Statistical

Sources of Economic Inequality Economists disagree about the extent of discrimination in the labor market. Firms that practice race or sex discrimination in the labor market would pay higher wages for the same marginal revenue product than firms that do not. profit margins for the firms practicing discrimination will be lower and the market price of their goods and services would be higher than non-discriminating firms. Nevertheless, still evidence of race/sex discrimination in field experiments.

Income Redistribution The governments in the United States use three main ways to redistribute income to alleviate some degree of economic inequality: Income taxes Income maintenance programs Subsidized services. Fight the caricature of capitalism as unfair/heartless Emphasize that there are no societies where income or wealth is equally distributed. There are two concerns: prosperity and equality. Private enterprise (capitalist) societies are, in general, more prosperous, and are in most cases (but not all) no less equal than socialist societies. Ask which is better for a family, to be the poorest in a rich but unequal society or equal with everyone else in a poor society. We vote for redistribution. Emphasize that we vote for policies that redistribute and we get the redistribution that the majority wants. To get more redistribution, we would need to change the rules about votes and give those who want more redistribution a bigger voice. That idea raises deep and serious questions.

Income Redistribution Taxes progressive regressive proportional

Income Redistribution Are each of the following progressive, proportional, or regressive? Sales tax Property tax Gas tax Cigarette taxes Payroll tax (e.g. Social Security)

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

Income Redistribution Subsidized Services Education Housing Food

The influence of government income redistribution efforts in 2001: The distribution after taxes and benefits is more equal than the distribution of market income. The three lower income groups gain and the highest income group loses. Income redistribution in the United States Point out the many different federal and state redistribution programs. Mention that assessing income shares after the impact of government redistribution programs, the U.S. Census Bureau estimates that the poorest quintile increased their share of total income by more than 400 percent (1.1 percent to 4.6 percent) in 2000. The second poorest quintile increased their income share by nearly as much as the poorest quintile. Surprisingly, the middle class received significant help as well, with the middle quintile increasing their income share by almost half the rate of the increase by the poorest quintile. The richest quintile lost 15 percent of their share of income (55.1 percent to 46.7 percent).

The Equity-Efficiency Tradeoff Programs to redistribute income are inefficient for three reasons: Use up resources that could have otherwise been used for producing goods and services. Taxes to support redistribution generate a deadweight loss in the markets that are taxed. Decreases incentives to work. The Big Tradeoff Emphasize that there is an opportunity cost to redistributing income in any society—when a dollar is taken from a rich person, a poor person receives less than a dollar. The size of the economic pie shrinks because: • Productive resources are used to implement the program rather than produce goods and services, • Redistribution requires taxations, which imposes a dead weight loss to society, and • The incentives facing the recipient of supplemental income are altered, delaying re-entry into the work force.