1. Income Inequality, Poverty and Discrimination
Chapter 21
In this chapter we will explore income inequality and actions that can be taken by government to try to correct income inequality, using the Lorenz curve and Gini ratio to help with this evaluation. We will then define poverty and look at how it affects different groups. We will also discuss government programs to aid families in poverty. Lastly we analyze discrimination and how this impacts wages.
Income Inequality, Poverty and Discrimination
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2. Facts About Income Inequality
Average household income
$69,821 in 2011
Among the highest in the world
Distribution by quintiles
Income mobility
People change quintiles
Government redistribution
Taxes and transfers
Income inequality is a continuing concern in much of the world. The classic case of the “haves” versus the “have-nots” has caused major disruptions in society. How to correct the disparity is of great debate among many. The United States’ average household income of $69,821 is among the highest in the world, but the distribution of income among the different groups varies with the top 20% of households earning more than 51% of total income. Over an individual’s lifetime, the individual or household may change quintiles as income changes. The government also attempts to redistribute the income through taxes and transfers, such as welfare and Social Security.
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3. Facts About Income Inequality
(1)
Personal
Income Category
(2)
Percentage of All
Households in this Category
Under $15,000
13.5
$15,000-$24,999
11.5
$25,000-$34,999
10.9
$35,000-$49,999
13.9
$50,000-$74,999
17.6
$75,000-$99,999
$100,000 and above
21.0
100.0
In this table, we can see the distribution of income among households in Note that approximately 25% of all households have an income of less than $25,000 while approximately 21% have income of more than $100,000. That means about 54% of households have income between $25,000- $99,999.
Source: Bureau of the Census, Numbers do not add up to 100 percent due to rounding.
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4. Facts About Income Inequality
Distribution by Quintiles, 2011
(2)
Percentage of
Total Income
(3)
Upper
Income Limit
(1)
Quintile
Lowest 20%
Second 20%
Third 20%
Fourth 20%
Highest 20%
Total
3.2
8.4
14.3
23.0
51.1
100.0
$20,262
38,520
62,434
101,582
No Limit
In this table, we see the households sorted into quintiles or fifths. This distribution also shows the upper income limit, meaning all households in that quintile have income below that level and above the previous level. The quintiles each contain an equal number of households so the bottom quintile only produces 3.2% of total income while the top quintile makes over 51% of it.
Source: Bureau of the Census,
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5. Facts About Income Inequality
Lorenz curve and Gini ratio 20 40 60 80
100 e
Lorenz Curve
(Actual Distribution)
Percentage of Households
Percentage of Income
Perfect Equality d A B c
Complete
Inequality
The Lorenz Curve is a graphical way to look at the relationship. The diagonal line that bisects the graph would illustrate perfect income equality, meaning all groups would have an equal distribution of income. Graphing the results of the U.S. income inequality gives us the curved line showing the unequal distribution. The Gini ratio is a numerical measurement of the overall dispersion of income. Lower ratios reflect less inequality while higher ratios indicate more inequality. b a f
Gini Ratio =
Area A
Area A + Area B
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6. Facts About Income Inequality
Impact of government taxes and transfers 20 40 60 80
100
Percentage of Households
Percentage of Income
Lorenz Curve
After Taxes and
Transfers
One economic function of government is to redistribute income. They do this by taxing households in higher income brackets and then distributing that money to households in lower brackets. The effect of these actions is to move the Lorenz Curve closer to the perfect equality line.
Lorenz Curve
Before Taxes and
Transfers
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7. Causes of Income Inequality
Ability
Education and training
Discrimination
Preferences and risks
Unequal distribution of wealth
Market power
Luck, connections, and misfortune
There are many different causes of income inequality. People have different abilities and talents, and this enables some people to perform in high-paying occupations such as being a doctor or star athlete while others can only perform basic tasks. Education and training can also impact a person’s earning capacity. Typically the higher the education level obtained, the higher the earning capacity. Discrimination of all forms as well as personal preferences and risk-aversions also affect an individual’s earnings. Being born into wealth certainly helps, as does just plain being lucky or having connections. Being in the right place at the right time is sometimes just the luck of the draw.
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8. Income Inequality Over Time
In this chart, we see the share of income in various nations that goes to the top 10% of receivers. For example, in Columbia, the top 10% of receivers gets almost 50% of the total income of the nation.
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9. Income Inequality Over Time
Rising income inequality since 1975
Causes of growing inequality
Greater demand for highly skilled workers
Demographic changes
International trade, immigration, and decline in unionism
Since 1975, there has been a growing income inequality in the U.S. The most likely reason for this growing inequality has been the increased demand for highly skilled workers. Modern manufacturing requires a highly educated workforce. Demographic changes also contributed; the “baby boomers” were entering the workforce during this time in waves of less-experienced and less-skilled workers. The growth of international trade and the transfer of jobs to lower-wage workers in other countries were factors as well.
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10. Income Inequality Over Time
This is another table showing the income earned by the different quintiles in the U.S. over time. Income was, more and more, unequal for many years, as the percentage of total income in the lowest quintile fell and the percentage of total income earned by the highest quintile rose. In 2011, we did see income take a very small increase in the lowest quintile and a decline in the highest quintile.
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11. Equality Versus Efficiency
The case for equality
Maximizing total utility
The case for inequality
Incentives and efficiency
The equality-efficiency trade-off
The main policy issue regarding income inequality is how much is necessary and justified. The basic argument for an equal distribution of income starts with the idea that income equality maximizes total consumer satisfaction from any particular level of output and income. Critics say that the transfer of income required to create income equality is unfair and unwise. They say income inequality reflects rewards to individuals for supplying their talents and resources to the economy, and that proponents of income falsely assume that there is some fixed amount of output and therefore income to be distributed. Regardless, there is a fundamental trade-off between equality and efficiency in that greater income equality comes at the opportunity cost of reduced production and income. Society must choose how much redistribution it desires in view of the costs.
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12. Equality Versus Efficiency
The Utility-Maximizing Distribution of Income
Anderson’s Marginal
Utility From Income
Brooks’ Marginal
Utility From Income
Marginal Utility
Income
Utility Gain
(Entire Blue Area)
Utility Loss
(Entire Red Area)
These graphs illustrate the utility-maximizing distribution of income. Both Anderson and Brooks will maximize their combined utility when any amount of income is equally distributed. If income is unequally distributed, the marginal utility derived from the last dollar will be greater for Anderson than for Brooks. a b’ a’ b
MUA
MUB
$2500
$5000
$5000
$7500
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13. The Economics of Poverty
Definition of poverty in 2011
Single person < $11,702
Family of 4 < $22,891
Family of 6 < $29,494
46.2 million Americans
Poverty rate 15%
Poverty is defined as a condition in which a person or family does not have the means to satisfy basic needs for food, clothing, shelter, and transportation. The Federal government has established minimum income thresholds below which a person or family are considered to be “in poverty.” As shown in the slide, in 2011, 15% of the population of the U.S. was living in poverty.
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14. Incidence of Poverty LO5
Poverty is disproportionately borne by African Americans, Hispanics, children, foreign-born residents who are not citizens, and families headed by women. People who are employed full-time, have a college degree, or are married tend to have low poverty rates.
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15. Poverty Trends Poverty rate trends Significant decline 1959-1969
Stable in 11-13% range since
Rises with recession
Measurement issues
Arbitrary income threshold
Consumption vs. income
In the decade between , the poverty rate declined significantly and was fairly stable in the range of 11-13% until the early 1980s when it started to rise. In 1993, the rate peaked at 15.1% and then began declining. The recession that began in December of 2007 increased the poverty rate for all groups, and many economists expect to see the rates rise even further as data for 2009 and 2010 becomes available. The rates and trends need to be interpreted cautiously. The income levels used to determine the rates are arbitrary thresholds and may not truly measure the extent of poverty in the U.S. The high cost of living in major metropolitan areas means that the official poverty thresholds may exclude many families whose income is slightly above the threshold but inadequate to meet basic needs.
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16. Poverty Trends
This graph shows the trend of the poverty rate among different groups between Although the national poverty rate declined sharply up to 1969, it stabilized in the 1970s; increased in the early 1980s; declined in the 1990’s; and has been relatively steady, with a slight increase, over the last several years.
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17. The U.S. Income-Maintenance System
Entitlement programs
All those eligible receive aid
Social insurance programs
Social security and Medicare
Unemployment compensation
Public assistance programs
Welfare
To help those who have very low income, the U.S. has a wide array of anti-poverty programs including subsidized employment, education and training programs, and anti-discrimination policies. These programs are referred to as entitlement programs because all eligible persons are legally entitled to receive their benefits.
The social insurance programs such as Social Security and unemployment compensation are designed to partially replace earnings that have been lost due to retirement, disability, or temporary unemployment. They are financed primarily out of Federal payroll taxes, and the benefits are viewed as earned rights as the recipients must have worked in order to be eligible to receive them.
Public assistance programs or welfare provide benefits to people who are unable to earn an income because of permanent disabling conditions, or who have no, or very low, income and also have dependent children. These programs are financed out of general tax revenues and are regarded as public charity.
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18. Public Assistance Programs
Supplemental Security Income (SSI)
Temporary Assistance for Needy Families (TANF)
Supplemental Nutrition Assistance Program (SNAP)
Medicaid
Earned Income Tax Credit
There are a wide variety of public assistance programs. The SSI program provides a uniform nationwide minimum income for the aged, blind, and disabled who are unable to work and who do not qualify for Social Security aid.
TANF assists families with children and has work requirements and a limit on the time a family can receive benefits.
SNAP, formerly known as the food-stamp program, permits low-income persons to obtain vouchers with which to buy food. Its goal is to ensure all low-income Americans have a nutritionally adequate diet.
Medicaid is a Federal program to provide basic medical care to people covered by the SSI and TANF programs.
The Earned Income Tax Credit is a refundable Federal tax credit provided to low-income wage earners. It is designed to supplement families’ income while encouraging them to work. These are just a few of the many programs administered by the government to assist those families faced with the challenges of poverty.
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19. Discrimination Inferior treatment Taste-for-discrimination model
Prejudiced people receive disutility
Willing to pay to avoid
Discrimination coefficient
Prejudice and the market African-American—White wage ratio
Competition and discrimination
Discrimination is the practice of treating people differently or exhibiting a bias for one group of people over other groups. Discrimination plays an important role in reducing wages for some and increasing wages for others. The taste-for-discrimination model examines prejudice in the emotion-free language of demand theory. It theorizes that discrimination results from a preference for which the discriminator is willing to pay. The discrimination coefficient attempts to measure this cost.
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20. Taste for Discrimination Model
Less
Discrimination S
More
Discrimination $9 8
African-American Wage Rate
(Dollars) 6
This graph illustrates the taste-for-discrimination model with a white employer discriminating against African-American workers. An increase in prejudice by white employers would decrease the demand for African-American workers from D1 to D2. Conversely, a decrease in the prejudice of the white employers would increase the demand for African-American workers. D3 D1 D2 12 16 18
African-American Employment (Millions)
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21. Discrimination Statistical discrimination
Judged on average group characteristics
Labor market example
Profitable, undesirable, but not malicious
The theory of statistical discrimination is based upon the concept that people are judged on the basis of the average characteristics of the group to which they belong, rather than on their own personal characteristics. Insurance rates for teen drivers reflect this type of discrimination. Merely because a driver is a young male, he automatically is charged higher insurance rates because on average, young males tend to have more accidents. The driving history of the individual is not the key factor. In the labor market, statistical discrimination occurs when employers fail to hire someone because of a preconceived notion about the group that the person is from. For example, an employer might hesitate to hire a female of child-bearing age out of concern that if she becomes pregnant, she will need time off or leave the place of employment which results in lower returns on the employer’s investment in training. The employer is not necessarily being malicious in failing to hire the person but is rather focused on the bottom line that is making as much profit as possible.
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22. Discrimination Occupational segregation The crowding model
Crowd certain groups into less desirable occupations
Effects of crowding
Eliminating occupational segregation
Cost to Society as well as to individuals
The third type of discrimination is occupational segregation. This discrimination tends to push certain groups into certain types of jobs. The notion that only men could be doctors and women should be nurses is an example.
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23. Occupational Segregation
Crowding women into one occupation (Z)…
Occupation X
Occupation Y
Occupation Z M M
Wage Rate B B B W Dx Dy Dz
In these graphs, we can see how the effects of occupational segregation result in the crowding of one class into one occupation, in this case Z. Because of the crowding, the labor supply is larger, thus driving down the wage rate. On the other hand, in occupations X and Y, the labor supplies are smaller resulting in higher wage rates. By eliminating occupational segregation, society benefits overall as wage rates equalize. 3 4 3 4 4 6
Quantity of Labor
(Millions)
results in men enjoying higher wages in the other occupations (X and Y).
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24. Median and Average Family Wealth, Survey Years 1995-2010
U.S. Family Wealth
Family wealth rose rapidly between 1995 and 2010
Median and Average Family Wealth, Survey Years
(In 2010 Dollars)
Year Median Average*
1995
1998
2001
2004
2007
2010
$84,000
98,100
106,100
107,200
126,400
77,300
$307,900
386,700
487,000
517,100
584,600
498,800
Family wealth increased substantially between 1995 and But then the collapse of the housing bubble and the recession of greatly reduced the typical family’s level of wealth.
*The average greatly exceeds the medians because the averages are boosted by the multibillion dollar wealth of a relatively few families.

25. Percentage of Total Family Wealth Held by Different Groups,
U.S. Family Wealth
Family wealth became more unequal between 1995 and 2010
Percentage of Total Family Wealth Held by Different Groups,
Survey Years
Percentage of Total Wealth by Group
Year
Bottom 90%
Top 10%
Top 1%
1995
1998
2001
2004
2007
2010
32.2%
31.4
30.2
30.4
28.5
23.3
67.8%
68.6
69.8
69.5
71.5
76.7
34.6%
33.9
32.7
33.4
33.8
35.4
This table illustrates the distribution of family wealth for various percentile groups and reveals that the distribution of wealth is highly unequal. The general trend is toward greater inequality. In 2010, the wealthiest 10% of families owned almost 77% of the total wealth. The lowest 90% saw their share fall from about 32% of total U.S. wealth in 1995 to only about 23% in 2010.