Chapter 31 Income, Poverty, and Health Care

Copyright © 2008 Pearson Addison Wesley. All rights reserved Introduction Some economists find that there is less “income mobility” than there used to be, yet others are not convinced. To understand the disagreement, we turn our attention to the distribution of income, a key topic in this chapter.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Learning Objectives Describe how to use a Lorenz curve to represent a nation’s income distribution Identify the key determinants of income differences across individuals Discuss theories of desired income distribution

Copyright © 2008 Pearson Addison Wesley. All rights reserved Learning Objectives (cont'd) Distinguish among alternative approaches to measuring and addressing poverty Recognize the major reasons for rising health care costs Describe alternative approaches to paying for health care

Copyright © 2008 Pearson Addison Wesley. All rights reserved Chapter Outline Income Determinants of Income Differences Theories of Desired Income Distribution Poverty and Attempts to Eliminate It Health Care

Copyright © 2008 Pearson Addison Wesley. All rights reserved Did You Know That... One of every 125 U.S. residents is a “millionaire?” About 30,000 people possess personal wealth exceeding $30 million? At the other end, there are 37 million U.S. residents in poverty?

Copyright © 2008 Pearson Addison Wesley. All rights reserved Income Income provides us a means of consuming and saving  Can be payment for labor  Can be payment for other factor  Can be from gifts and government transfers

Copyright © 2008 Pearson Addison Wesley. All rights reserved Income (cont'd) Distribution of Income  The way income is allocated among the population

Copyright © 2008 Pearson Addison Wesley. All rights reserved Income (cont'd) Lorenz Curve  A geometric representation of the distribution of income  A Lorenz curve that is perfectly straight represents complete income equality.  The more bowed a Lorenz curve, the more unequally income is distributed.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Figure 31-1 The Lorenz Curve

Copyright © 2008 Pearson Addison Wesley. All rights reserved Income (cont'd) Criticisms of the Lorenz curve 1. It does not include income in kind: income received in the form of goods and services. 2. It does not account for the differences in size of households or the number of wage earners households contain.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Income (cont'd) Criticisms of the Lorenz curve 3. It does not account for age differences. 4. It ordinarily reflects money income before taxes. 5. It does not measure unreported income.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Figure 31-2 Lorenz Curves of Income Distribution, 1929 and 2007

Copyright © 2008 Pearson Addison Wesley. All rights reserved Table 31-1 Percentage Share of Money Income for Households Before Direct Taxes

Copyright © 2008 Pearson Addison Wesley. All rights reserved Example: Why it is Misleading to Examine Only Wages and Salaries Today, only about 52% of national income is derived from wages and salaries. Total compensation received has remained close to 70% of national income.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Figure 31-3 Wages and Salaries and Total Labor Compensation as Percentages of U.S. National Income

Copyright © 2008 Pearson Addison Wesley. All rights reserved The Distribution of Wealth Income—a flow—can be viewed as a return on wealth—a stock. The distribution of income is not the same as the distribution of wealth. Wealth includes tangible objects and human wealth.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Figure 31-4 Measured Total Wealth Distribution

Copyright © 2008 Pearson Addison Wesley. All rights reserved Determinants of Income Differences We know there are income differences; that is not in dispute. A more important question is why these differences occur. If we know, perhaps we can change policy, or better understand them.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Determinants of Income Differences (cont'd) We will look at four determinants of income differences 1. Age 2. Marginal productivity 3. Inheritance 4. Discrimination

Copyright © 2008 Pearson Addison Wesley. All rights reserved Determinants of Income Differences (cont'd) Age-Earnings Cycle  The regular earnings profile of an individual throughout his or her lifetime

Copyright © 2008 Pearson Addison Wesley. All rights reserved Determinants of Income Differences (cont'd) Age-earnings cycle  At age 18, earnings from wages are relatively low.  Earnings gradually rise until they peak at about age 50.  Earnings then fall until retirement, when they become zero.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Figure 31-5 Typical Age-Earnings Profile

Copyright © 2008 Pearson Addison Wesley. All rights reserved Determinants of Income Differences (cont'd) Marginal productivity  Talent  Experience  Training  Investment in human capital

Copyright © 2008 Pearson Addison Wesley. All rights reserved Determinants of Income Differences (cont'd) Inheritance  10% of inequality traced to inheritance Discrimination  Different pay for equal MRP  Equal pay for different MRP

Copyright © 2008 Pearson Addison Wesley. All rights reserved Determinants of Income Differences (cont'd) Access to education  Minorities face discrimination in the acquisition of human capital.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Determinants of Income Differences (cont'd) Doctrine of Comparable Worth  The belief that women should receive the same wages as men if the levels of skill and responsibility in their jobs are equivalent

Copyright © 2008 Pearson Addison Wesley. All rights reserved Theories of Desired Income Distribution The productivity standard  “To each according to what she or he produces”  Also called the contributive standard, or referred to as the merit standard Equality—the egalitarian principle  “To each exactly the same”

Copyright © 2008 Pearson Addison Wesley. All rights reserved Poverty and Attempts to Eliminate It Throughout history mass poverty has been accepted as inevitable. Sustained economic growth has wiped out mass poverty in many countries. How can there be so much poverty in a nation of such abundance?

Copyright © 2008 Pearson Addison Wesley. All rights reserved Figure 31-6 Official Number of Poor in the United States, Panel (a) Source: U.S. Department of Labor

Copyright © 2008 Pearson Addison Wesley. All rights reserved Figure 31-6 Official Number of Poor in the United States, Panel (b) Source: U.S. Department of Labor

Copyright © 2008 Pearson Addison Wesley. All rights reserved Poverty and Attempts to Eliminate It (cont'd) Defining poverty  Official poverty level in 2007 for an urban family of four around $21,000  Adjusted based on CPI  Does not include cash and non-cash transfer payments Absolute poverty not the same as relative poverty  In a relative sense, poverty will always exist even if absolute poverty eliminated.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Source: Bureau of Labor Statistics; U.S. Bureau of the Census Figure 31-7 Relative Poverty: Comparing Household Income and Household Spending

Copyright © 2008 Pearson Addison Wesley. All rights reserved Poverty and Attempts to Eliminate It (cont'd) Attacks on poverty: major income maintenance programs  Social Security which has been called OASDI  90% of all employed persons covered  In 2007, 49 million people received checks averaging $960 a month.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Poverty and Attempts to Eliminate It (cont'd) Supplemental Security Income (SSI)  Minimum income for the  Aged  Blind  Disabled

Copyright © 2008 Pearson Addison Wesley. All rights reserved Poverty and Attempts to Eliminate It (cont'd) Temporary Assistance to Needy Families (TANF)  State administered program financed in part by federal grants  The program provides aid to families in need.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Poverty and Attempts to Eliminate It (cont'd) Food stamps  Government-issued coupons (or e-debit cards) that can be used to purchase food  In 1964, some 367,000 Americans received food stamps.  In 2007, one in nine citizens received food stamps.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Policy Example: What are Food Stamps Worth? Recipients qualify for food stamps because they have low incomes. There are times when these recipients need cash more than food stamps. Diane Whitmore of the University of Chicago sought to determine value.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Policy Example: What are Food Stamps Worth? (cont'd) She found 20 to 30% purchased more food (than if they received cash). This group placed an average cash value of 80 cents per $1 in food stamps. She found that stamps trade in the underground market for 65 cents per $1.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Poverty and Attempts to Eliminate It (cont'd) Earned Income Tax Credit Program (EITC)  Designed to provide rebates to low- income workers  Each year federal government grants $36 billion in benefits.  Over one-fifth of all tax returns claim an EITC.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Poverty and Attempts to Eliminate It (cont'd) No apparent reduction in poverty  1973: 11%  1983: 15%  1990: 13.1%  Since fallen to 12%

Copyright © 2008 Pearson Addison Wesley. All rights reserved Health Care Health care is intimately related to the distribution of income and poverty

Copyright © 2008 Pearson Addison Wesley. All rights reserved Health Care (cont'd) America’s health care situation  Portion of national income spent on health care has risen steadily since  16% of U.S. real GDP is devoted to spending on health care.  Per capita spending greater than anywhere else in the world

Copyright © 2008 Pearson Addison Wesley. All rights reserved Source: U.S. Department of Commerce; U.S. Department of Health and Human Services; Deloitte and Touch LLP; VHA, Inc. Figure 31-8 Percentage of Total National Income Spent on Health Care in the United States

Copyright © 2008 Pearson Addison Wesley. All rights reserved Health Care (cont'd) Question  Why have health care costs risen so much? Answers  The age-health care expenditure equation  New technologies  Third-party financing

Copyright © 2008 Pearson Addison Wesley. All rights reserved Health Care (cont'd) Third Parties  Parties who are not directly involved in a given activity or transaction  Fees may be paid by third parties (insurance companies, government)

Copyright © 2008 Pearson Addison Wesley. All rights reserved Source: Health Care Financing Administration; U.S. Department of Health and Human Services Figure 31-9 Third-Party versus Out-of-Pocket Health Care Payments

Copyright © 2008 Pearson Addison Wesley. All rights reserved Health Care (cont'd) Price, quantity demanded, and moral hazard  Large percent of medical services payments made by third parties  Price to the consumer drops and the quantity demanded increases  An individual with a zero deductible may engage in a less healthful lifestyle

Copyright © 2008 Pearson Addison Wesley. All rights reserved Figure The Demand for Health Care Services At P 1 quantity demanded is Q 1 If the price falls to zero, quantity demanded increases to Q 2

Copyright © 2008 Pearson Addison Wesley. All rights reserved Health Care (cont'd) Moral hazard as it affects physicians and hospitals  Due to third-party payments, patients do not have to worry about the cost of operations and medical procedures.  Physicians and hospitals order more of them since they are reimbursed on the basis of medical procedures.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Health Care (cont'd) Medicare expenditures are one of the most serious problems facing the federal government today. The number of beneficiaries has increased from 19.1 million in 1966 to more than 40 million in Federal spending on Medicare has increased about 10% a year, adjusted for inflation.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Figure Federal Medicare Spending

Copyright © 2008 Pearson Addison Wesley. All rights reserved Health Care (cont'd) Is national health insurance the answer?  Over 40 million Americans are uninsured at some point during the year.  Federal spending might increase from $60 to $100 billion.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Health Care (cont'd) Countering the moral hazard problem: Health Savings Account (HSA)  A tax-exempt health care account  To which individuals can pay on a regular basis  And out of which medical care expenses can be paid

Copyright © 2008 Pearson Addison Wesley. All rights reserved Issues and Applications: Is the United States No Longer an Income-Mobile Nation? Past evidence supporting high U.S. income mobility. Is mobility giving way to more rigid income-class structure? Recent immigrants complicate interpreting the data.

Copyright © 2008 Pearson Addison Wesley. All rights reserved Summary Discussion of Learning Objectives Using a Lorenz curve to represent a nation’s income distribution  The more bowed a Lorenz curve, the more unequally income is distributed Key determinants of income differences across individuals  Age  Marginal productivity differences  Discrimination

Copyright © 2008 Pearson Addison Wesley. All rights reserved Summary Discussion of Learning Objectives (cont'd) Theories of desired income distribution  Productivity standard  Egalitarian principle Alternative approaches to measuring and addressing poverty  Absolute poverty standard  Relative poverty standard

Copyright © 2008 Pearson Addison Wesley. All rights reserved Summary Discussion of Learning Objectives (cont'd) Major reasons for rising health care costs  Aging U.S. population  Higher priced medical technologies  Third-party financing of health care expenditures  Moral hazard

Copyright © 2008 Pearson Addison Wesley. All rights reserved Summary Discussion of Learning Objectives (cont'd) Alternative approaches to paying for health care  Governmental funding  Income-based national health insurance program  Health savings accounts

End of Chapter 31 Income, Poverty, and Health Care