Transcript Principles of Economics Third Edition by Fred Gottheil

Chapter 18
Income Distribution
and Poverty
© 2005 Thomson
Economic Principles
The Lorenz curve
The Gini coefficient
Rawls’s theory of justice
Life cycle wealth
The case for income equality
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Economic Principles
The case for income inequality
Poverty thresholds
Negative income tax
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Income Distribution
and Poverty
Questions about the rich and the
poor arise from the political,
ethical, economic and religious
foundations of our society.
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Income Distribution
and Poverty
Questions include:
• Why are some people rich and others
poor?
• Why does it seem there are so many
more poor than rich?
• Can anything be done about the
situation?
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Income Distribution
and Poverty
These questions concerning income
distribution haven’t changed much
in the last 2,500 years.
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Income Distribution
and Poverty
There is one difference, however.
Today, it is commonly recognized
that a person’s income seems to be
connected to that person’s
productive contribution in the
market.
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Not Too Many Coal Miners
Are Millionaires
There are four forms of income:
• Wages
• Interest
• Rent
• Profit
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Not Too Many Coal Miners
Are Millionaires
One can generally guess a person’s
economic status by knowing the
principal source of the person’s
income.
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Not Too Many Coal Miners
Are Millionaires
When there is a shift in either the
supply curves or MRP curves of
labor, capital, or land, the
equilibrium wage rates, interest
rates, and rents also change.
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Not Too Many Coal Miners
Are Millionaires
People’s income increases or
decreases as a result of these
changes.
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Measuring Income Distribution
There are two principal ways to
measure an economy’s income
distribution:
• The Lorenz curve
• The Gini coefficient
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Measuring Income Distribution
Lorenz curve
• A curve depicting an economy’s income
distribution. It records the percentage of
total income that a specific part of the
population—typically represented by
quintiles, ranging from the poorest to the
richest—receives.
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Measuring Income Distribution
Lorenz curve
• The percentage of population is measured
along the horizontal axis and the
percentage of total income is measured
along the vertical axis.
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Measuring Income Distribution
Perfect income equality is achieved
when each percent of the population
receives an equal percent of the
economy’s total income. The perfect
income equality curve on the
Lorenz curve is a diagonal.
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Measuring Income Distribution
For example, if 20 percent of the
people receive 20 percent of the
income, then there is perfect
income equality.
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Measuring Income Distribution
Perfect income inequality is
achieved when one person receives
all of the income and everyone else
receives no income. The prefect
income inequality curve on a
Lorenz curve is formed by the two
sides of a right angle.
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Measuring Income Distribution
In reality all income distributions
lie somewhere between perfect
equality and perfect inequality.
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EXHIBIT 1
LORENZ CURVES
FOR THE COMMUNITIES OF
WASHTENAU,
SPRINGFIELD,
AND HOLMES
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Exhibit 1: Lorenz Curves for the
Communities of Washtenau,
Springfield, and Holmes
What percentage of total income
do the poorest 20 percent of the
population receive in Washtenau,
Springfield and Holmes?
• They receive 20 percent of total income in
Washtenau, 0 percent in Springfield and 4
percent in Holmes.
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EXHIBIT 2
LORENZ CURVES FOR SWEDEN, FRANCE,
BRAZIL, AND THE UNITED STATES
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Exhibit 2: Lorenz Curves for
Sweden, France, Brazil and the
United States
Which country in Exhibit 2 has
the greatest income equality? The
least?
• Sweden has the greatest income equality,
while Brazil has the least.
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Measuring Income
Distribution
• The Lorenz curve is not perfect and
is, at best, only a rough estimate of the
underlying reality.
• For example, the distribution of
government-provided goods such as
national security, health care and
transportation are impossible to
account for in the Lorenz curve.
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Measuring Income
Distribution
Gini coefficient
• A numerical measure of the degree of
income inequality in an economy. It ranges
from zero, depicting perfect equality, to
one, depicting perfect inequality.
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Measuring Income
Distribution
The coefficient is a ratio of the two
areas produced by the Lorenz
curve. Area A lies between the
diagonal and the economy’s Lorenz
curve. Area B lies below the
economy’s Lorenz curve.
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Measuring Income
Distribution
The coefficient (G) is calculated as
G = A/(A + B).
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EXHIBIT 3
THE GINI COEFFICIENT
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Exhibit 3: The Gini Coefficient
As the area represented by A in
Exhibit 3 becomes smaller, the
Gini coefficient becomes:
i. Smaller
ii. Larger
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Exhibit 3: The Gini Coefficient
As the area represented by A in
Exhibit 3 becomes smaller, the
Gini coefficient becomes:
i. Smaller
ii. Larger
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How Unequal is Our Income
Distribution?
An overall upward drift toward
greater income inequality shows
up in the Lorenz curve and Gini
coefficient between 1970 and 1995
in the United States.
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EXHIBIT 4
SHARE OF AGGREGATE INCOME
RECEIVED BY HOUSEHOLDS, BY QUINTILE
AND TOP 5 PERCENT, AND GINI
COEFFICIENT: 1970–2001
Source: U.S. Bureau of the Census, Money Income in the United States: 2001, Current Population Reports (Washington, D.C.: U.S. Government
Printing Office, 2001).
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Exhibit 4: Share of Aggregate Income
Received by Households, By Quantile
and Top 5 Percent, and Gini
Coefficient: 1970-2000
How has the share of total income
received by the top 5 percent
changed in the U.S. since 1970?
• The top 5 percent received about 16
percent of the total income in 1970. In
2001 the percentage had increased to
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EXHIBIT 5
PERCENTAGE CHANGE IN HOUSEHOLD
GINI COEFFICIENT: 1967–99
Source: U.S. Bureau of the Census, Current Population Survey, March 1999.
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Exhibit 5: Percentage Change in
Household Gini Coefficient: 1967-99
The curve in Exhibit 5 is upward
sloping. Does this mean income is
becoming more equal or less?
• Income is becoming less equal, since the
cumulative percentage change is positive.
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How Unequal Is Our Income
Distribution?
The increase in income inequality
seen in the U.S. is similar to the
pattern in some developed
countries, while other developed
countries seem to be more
egalitarian.
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How Unequal Is Our Income
Distribution?
In developing countries, income
inequality is extreme. Many
economists attribute the inequality
to their agrarian economies. The
prospect for breaking out depends
on the creation of nonagricultural
employment.
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EXHIBIT 6
INCOME DISTRIBUTION IN THE MID-1990s,
SELECTED COUNTRIES, BY QUINTILE
Source: European Economy: 1996 Broad Economic Policy Guidelines, no. 62 (Brussels, 1996), and World Development Report, 2000/2001
(Washington, D.C.: World Bank, 2000/2001).
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Exhibit 6: Income Distribution in
the Mid-1990s, Selected
Countries, By Quintile
Which countries show similar
patterns in income distribution in
Exhibit 6?
• France, United Kingdom, and Canada all share
a similar distribution while Japan, the
Netherlands, and Sweden share a more
egalitarian distribution.
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EXHIBIT 7
INCOME DISTRIBUTION IN LESS-DEVELOPED
ECONOMIES, BY QUINTILE
Source: World Development Report, 1996 (Washington, D.C.: World Bank, 1996). The footnote to the table in the report reads: “These estimates
should be treated with caution.”
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Exhibit 7: Income Distribution in LessDeveloped Economies, by Quintile
How does the percentage of
wealth received by the top 20
percent in this exhibit compare to
Exhibit 6?
• The top 20 percent in the less-developed
countries receive a much greater share of
total income than the top 20 percent in
developed countries.
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How Unequal Is Our Income
Distribution?
Wealth
• The accumulated assets owned by
individuals.
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How Unequal Is Our Income
Distribution?
Life-cycle wealth
• Wealth in the form of nonmonetary
assets, such as a house, automobiles, and
clothing.
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How Unequal Is Our Income
Distribution?
• Wealth represents the
accumulated assets of a lifetime,
including inherited assets.
• Net wealth among population
deciles tends to be far more
unevenly distributed than
income.
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EXHIBIT 8
DISTRIBUTION OF NET WEALTH OF U.S.
FAMILIES (1774 AND 1973)
Source: Jones, A. H., Wealth of a Nation to Be—The American Colonies on the Eve of Revolution
(New York: Columbia University Press, 1980); and Greenwood, D., “An Estimation of U.S. Family
Wealth and Its Distribution from Macro Data, 1973,” The Review of Income and Wealth, Series 29, I,
March 1983, pp. 23–44.
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Exhibit 8: Distribution of Net Wealth of
U.S. Families (1774 and 1973)
How much of the nation’s wealth did
the wealthiest decile hold in 1973?
And the least wealthy 50 percent?
• The wealthiest 10 percent of the
population held 69.8 percent of the wealth
while the least wealthy 50 percent held just
1 percent of the wealth.
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Is There an Optimal Income
Distribution? The Case for Equality
Some argue that good fortune, as
well as disaster, are distributed
randomly. Income inequality,
then, has no more justification
than a lottery result.
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Is There an Optimal Income
Distribution? The Case for Equality
Harvard philosopher John Rawls
agrees. He believes that people
who look at income distribution
alternatives objectively, would
always choose less income
inequality.
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Is There an Optimal Income
Distribution? The Case for Equality
Others, particularly Marxists, argue
for income equality based on the idea
that people are created equally. They
believe that individuals come to own
property by theft. The unequal
distribution of property creates
income inequality.
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Is There an Optimal Income
Distribution? The Case for Equality
Still others, particularly economist
A.P. Lerner, make the case for
equality based on the presumption
that equality produces the greatest
welfare for the greatest number of
people.
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EXHIBIT 9
EQUALITY AND MAXIMUM UTILITY
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Exhibit 9: Equality and
Maximum Utility
Where is combined total utility
maximized in Exhibit 9?
• Combined total utility is maximized at
equality—when each person has $10.
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Is There an Optimal Income Distribution?
The Case for Inequality
Other economists argue for income
inequality by drawing on the
connection between productive
contribution and economic reward.
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Is There an Optimal Income Distribution?
The Case for Inequality
The argument is that without the
reward linkage, productive people
would lack the incentive to
contribute as much as they do.
The economy’s output would be
less than its productive potential.
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Is There an Optimal Income Distribution?
The Case for Inequality
Even though total national income
may fall as a result of
redistributing wealth toward
greater equality, however, the
poor may still be better off.
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EXHIBIT 10 EFFECT OF INEQUALITY ON NATIONAL
INCOME
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Exhibit 10: Effect of Inequality on
National Income
1. How does national income
change as the Gini coefficient
moves from 0.45 to 0.35?
• National income declines from $900 billion
to $700 billion as the Gini coefficient
declines.
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Exhibit 10: Effect of Inequality on
National Income
2. How does the income received
by the poorest 60 percent change?
• Although national income declines, the
income received by the poorest 60 percent
increases from $300 billion to $350 billion.
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Is There an Optimal Income Distribution?
The Case for Inequality
Income inequality may also lead
to economic growth. The rich tend
to do the country’s investing. The
richer the rich, the greater the
investment and the higher the rate
of growth.
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Is There an Optimal Income Distribution?
The Case for Inequality
The poor may even benefit from
the inequality. Even though their
share of national income is
relatively small, as investments
grow and the economy grows, the
absolute size of their share will
increase.
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EXHIBIT 11 INEQUALITY AND ECONOMIC GROWTH
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Exhibit 11: Inequality and
Economic Growth
What happens to the income
received by the poorest 60 percent
after 15 years in Exhibit 11?
• After 15 years, the income received by
the poorest 60 percent in the more unequal
society (G = 0.45) surpasses that of the
more equal society (G = 0.35).
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Do We Have to Live with Poverty?
To many people, poverty is a
relative concept. People are only
poor relative to others. How many
live in poverty, then, depends not on
a person’s particular income, but
upon the relationship between that
income and the income of others.
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Do We Have to Live with Poverty?
Median income
• The midpoint of a society’s income
distribution, above and below which an
equal number of individuals (or families)
belong.
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Do We Have to Live with Poverty?
Poverty threshold
• The level of income below which families
are considered to be poor.
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Do We Have to Live with Poverty?
Another way of identifying poverty
is by describing some minimal
acceptable physical standard of
living that people ought to have.
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EXHIBIT 12 PERCENTAGE OF PERSONS BELOW THE
POVERTY LEVEL, BY RACE, 1960-2000
NA = not available
* Refers to data for 1959
Source: Bureau of the Census, Statistical Abstract of the United States, 2002 (Washington, D.C.; Department of Commerce, 202), p. 442.
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Exhibit 12: Percentage of Persons Below
the Poverty Level, by Race, 1960-2000
How has the number of people living
in poverty changed since 1960?
• Between 1960 and 1970 the number of
people living in poverty dropped
dramatically from over 22 percent to
about 12 percent. It has held fairly steady
since then.
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EXHIBIT 13 FAMILIES IN POVERTY, BY SELECTED
CHARACTERISTICS: 2000
* Refers to 1994
Source: Statistical Abstract of the United States, 2002 (Washington, D.C.: Department of Commerce, 2002), p. 444.
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Exhibit 13: Persons and Families
in Poverty, by Selected
Characteristics: 2000
According to Exhibit 13, what
characteristic was most associated
with poverty in 2000?
• Within this list, families headed by a
single mother were at the highest risk for
living in poverty.
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Fighting the War on Poverty
Cash assistance
• Government assistance in the form
of cash.
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Fighting the War on Poverty
In-kind assistance
• Government assistance in the form of
direct goods and services, such as Medicaid
or food stamps.
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EXHIBIT 14 CASH AND NONCASH BENEFITS FOR
PERSONS WITH LIMITED INCOME: 2001
Source: Statistical Abstract of the United States, 2002 (Washington, D.C.: Department of Commerce, 2002), p. 344.
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Exhibit 14: Cash and Noncash
Benefits for Persons with Limited
Income: 2001
What types of programs for the
poor has the government funded?
• Medical care, food, housing, education,
job training, energy assistance and cash
aid are all programs supported by the
government.
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EXHIBIT 15 POPULATION BELOW 50 PERCENT OF
MEDIAN INCOME (LATEST OECD DATA)
Source: OECD Economic Surveys, Germany, 1996 (Paris: OECD, 1996), P. 90.
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Exhibit 15: Population Below 50
Percent of Median Income
(Latest OECD Data)
Has government spending to assist the
poor been effective at raising families
out of poverty?
• The effects of low-income assistance programs
seem barely perceptible. While some countries
have seen the numbers of poor drop by half, the
U.S. number have dropped by less than
1 percent.
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The Negative Income Tax
Alternative
Negative income tax
• Government cash payments to the poor—
an income tax in reverse—that is linked to
the income levels of the poor. The cash
payments decrease as income levels
increase. The payments are designed to
provide a minimum level of income to
the poor.
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The Negative Income Tax
Alternative
Under this scheme, the poor are
provided with enough money to
maintain a minimum standard of
living and are allowed to earn as
much as possible without penalty.
It creates an incentive to work.
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EXHIBIT 16 THE NEGATIVE INCOME TAX APPLIED
(TAX = 50%)
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Exhibit 16: The Negative Income
Tax Applied (Tax = 50%)
If the government sets a minimum
income level of $10,000 and incomes
are taxed at 50 percent, what would
be the after-tax income of a family
earning $10,000?
• The family’s tax obligation would be
($10,000 × 50%) = $5,000.
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Exhibit 16: The Negative Income
Tax Applied (Tax = 50%)
If the government sets a minimum
income level of $10,000 and incomes
are taxed at 50 percent, what would
be the after-tax income of a family
earning $10,000?
• This leaves an after-tax income
independently derived of $5,000.
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Exhibit 16: The Negative Income
Tax Applied (Tax = 50%)
If the government sets a minimum
income level of $10,000 and incomes
are taxed at 50 percent, what would
be the after-tax income of a family
earning $10,000?
• The family still receives the $10,000
negative income tax, so total after-tax
income is $15,000.
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