Income Distribution

Circular Flow The circular flow diagram shows that income to the resources comes from the resource markets. A person’s income depends upon two factors: –How much of the resource do they have? –What price will the resource bring? The resources are labor, entreprenuership, capital, and natural resources (%of national income) –Labor (57%) –Proprietor (7%), Corporate Profits (8%) –Interest (7%) –Rent (1%)

Figure 1 The Circular Flow Copyright © 2004 South-Western Spending Goods and services bought Revenue Goods and services sold Labor, land, and capital Income = Flow of inputs and outputs = Flow of dollars Factors of production Wages, rent, and profit FIRMS Produce and sell goods and services Hire and use factors of production Buy and consume goods and services Own and sell factors of production HOUSEHOLDS Households sell Firms buy MARKETS FOR FACTORS OF PRODUCTION Firms sell Households buy MARKETS FOR GOODS AND SERVICES

The primary source of income for most Americans comes from labor The supply and demand for labor determine: –How much labor do they provide/used? –How much does labor get paid? –Demand for labor is a derived demand. Business firms employ labor to produce and sell output. Hire labor until the MB L =MC L –Supply of labor is a decision of households that comes from a choice between work, and hence income and the ability to buy goods and services, and leisure. They will supply labor until the MB W =MC W. The benefits are satisfaction from goods and services and the costs are the satisfaction lost from forgone leisure.

Wage Determination The relationship between the demand for labor and the wage rate is negative or the demand curve for labor is down-ward sloping. The relationship between the supply of labor and the wage rate is psotive or the supply curve of labor is up-ward sloping.

Differences in Wages Compensating Differentials: providing incentives to overcome such differences as difficulty, stress, danger, and nightwork. These rise the MC of supplying labor. Human Capital: higher skills result in greater productivity. Human capital increases the MB of hiring labor. –Education

Table 1 Average Annual Earnings by Educational Attainment Copyright©2004 South-Western

Above Equilibrium Wages The minimum wage – a legally set price floor for wages. Collective bargaining – agreement among workers to bargain together through a union for wages. Efficiency Wages – wages paid to increase productivity and/or reduce worker turnover.