Transcript Is There an Optimal Income Distribution?

Chapter 18
Income Distribution
and Poverty
© 2002 South-Western
Economic Principles
•The Lorenz curve
•The Gini coefficient
•Rawls’s theory of justice
•Life cycle wealth
•The case for income equality
2
Economic Principles
•The case for income inequality
•Poverty thresholds
•Negative income tax
3
Income Distribution
and Poverty
Questions about the rich and the
poor arise from the political,
ethical, economic and religious
foundations of our society.
4
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?
5
Income Distribution
and Poverty
These questions concerning
income distribution haven’t
changed much in the last 2,500
years.
6
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.
7
Not Too Many Coal Miners
Are Millionaires
There are four forms of income:
• Wages.
• Interest.
• Rent.
• Profit.
8
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.
9
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.
10
Not Too Many Coal Miners
Are Millionaires
People’s income increases or
decreases as a result of these
changes.
11
Measuring Income
Distribution
There are two principal ways to
measure an economy’s income
distribution:
• The Lorenz curve.
• The Gini coefficient.
12
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.
13
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.
14
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.
15
Measuring Income
Distribution
For example, if 20 percent of the
people receive 20 percent of the
income, then there is perfect
income equality.
16
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.
17
Measuring Income
Distribution
In reality all income distributions
lie somewhere between perfect
equality and perfect inequality.
18
EXHIBIT 1
LORENZ CURVES
FOR THE COMMUNITIES OF
WASHTENAU,
SPRINGFIELD,
AND HOLMES
19
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.
20
EXHIBIT 2
LORENZ CURVES FOR SWEDEN, FRANCE,
BRAZIL, AND THE UNITED STATES
21
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.
22
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.
23
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.
24
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.
25
Measuring Income
Distribution
The coefficient (G) is calculated as
G = A/(A+B).
26
EXHIBIT 3
THE GINI COEFFICIENT
27
Exhibit 3: The Gini
Coefficient
As the area represented by A in
Exhibit 3 becomes smaller, the
Gini coefficient becomes:
i. Smaller.
ii. Larger.
28
Exhibit 3: The Gini
Coefficient
As the area represented by A in
Exhibit 3 becomes smaller, the
Gini coefficient becomes:
i. Smaller.
29
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.
30
EXHIBIT 4
SHARE OF AGGREGATE INCOME
RECEIVED BY HOUSEHOLDS, BY QUINTILE
AND TOP 5 PERCENT, AND GINI
COEFFICIENT: 1970–99
Source: U.S. Bureau of the Census, Money Income in the United States: 1995, Current Population Reports, P60-193 (Washington, D.C.: U.S.
Government Printing Office, 1996); and U.S. Bureau of the Census, Money Income in the United States: 1999, Current Population Reports, P60-220
(Washington, D.C.: U.S. Government Printing Office, 1999).
31
Exhibit 4: Share of Aggregate
Income Received by Households, By
Quantile and Top 5 Percent, and
Gini Coefficient: 1970-1999
How has the share of total income
received by the top 5 percent
changed in the US since 1970?
• The top 5 percent received about 16
percent of the total income in 1970. In 1995
the percentage had increased to 21 percent.
32
EXHIBIT 5
PERCENTAGE CHANGE IN HOUSEHOLD
GINI COEFFICIENT: 1967–99
Source: U.S. Bureau of the Census, Current Population Survey, March 1999.
33
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.
34
How Unequal Is Our Income
Distribution?
The increase in income inequality
seen in the US is similar to the
pattern in some developed
countries, while other developed
countries seem to be more
egalitarian.
35
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.
36
EXHIBIT 6
INCOME DISTRIBUTION IN THE MID-1980s,
SELECTED COUNTRIES, BY QUINTILE
Source: European Economy: 1996 Broad Economic Policy Guidelines, no. 62 (Brussels, 1996), and World Development Report, 1996
(Washington, D.C.: World Bank, 1996).
37
Exhibit 6: Income Distribution in
the Mid-1980s, Selected
Countries, By Quintile
Which countries show similar
patterns in income distribution in
Exhibit 6?
• Italy, France, United Kingdom and
Canada all share a similar distribution
while Japan, the Netherlands, Sweden and
West Germany share a more egalitarian
distribution.
38
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.”
39
Exhibit 7: Income Distribution in
Less-Developed 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.
40
How Unequal Is Our Income
Distribution?
Wealth
The accumulated assets owned by
individuals.
41
How Unequal Is Our Income
Distribution?
Life-cycle wealth
Wealth in the form of
nonmonetary assets, such as a
house, automobiles, and clothing.
42
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.
43
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.
44
Exhibit 8: Distribution of Net
Wealth of US 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
45
1 percent of the wealth.
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.
46
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.
47
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.
48
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.
49
EXHIBIT 9
EQUALITY AND MAXIMUM UTILITY
50
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.
51
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.
52
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.
53
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.
54
EXHIBIT 10 EFFECT OF INEQUALITY ON NATIONAL
INCOME
55
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.
56
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.
57
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.
58
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.
59
EXHIBIT 11 INEQUALITY AND ECONOMIC GROWTH
60
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).
61
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.
62
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.
63
Do We Have to Live with
Poverty?
Poverty threshold
The level of income below which
families are considered to be poor.
64
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.
65
EXHIBIT 12 PERCENTAGE OF PERSONS BELOW THE
POVERTY LEVEL, BY RACE, 1960-97
NA = not available
* Refers to data for 1959
Source: Bureau of the Census, Statistical Abstract of the United States, 1999 (Washington, D.C.; Department of Commerce, 1999), p. 483.
66
Exhibit 12: Percentage of
Persons Below the Poverty
Level, by Race, 1960-95
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.
67
EXHIBIT 13 FAMILIES IN POVERTY, BY SELECTED
CHARACTERISTICS: 1997
* Refers to 1992
† Refers to 1994
Source: Statistical Abstract of the United States, 1999 (Washington, D.C.: Department of Commerce, 1999), p. 484.
68
Exhibit 13: Persons and
Families in Poverty, by Selected
Characteristics: 1997
According to Exhibit 13, what
characteristic was most associated
with poverty in 1997?
• Within this list, families headed by a
single mother were at the highest risk
for living in poverty.
69
Fighting the War
on Poverty
Cash assistance
Government assistance in the
form of cash.
70
Fighting the War
on Poverty
In-kind assistance
Government assistance in the
form of direct goods and services,
such as Medicaid or food stamps.
71
EXHIBIT 14 CASH AND NONCASH BENEFITS FOR
PERSONS WITH LIMITED INCOME: 1996
Source: Statistical Abstract of the United States, 1999 (Washington, D.C.: Department of Commerce, 1999), p. 389.
72
Exhibit 14: Cash and Noncash
Benefits for Persons with
Limited Income: 1994
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.
73
EXHIBIT 15 POPULATION BELOW 50 PERCENT OF
MEDIAN INCOME (LATEST OECD DATA)
Source: OECD Economic Surveys, Germany, 1996 (Paris: OECD, 1996), P. 90.
74
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 US number have
dropped by less than 1 percent.
75
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.
76
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.
77
EXHIBIT 16 THE NEGATIVE INCOME TAX APPLIED
(TAX = 50%)
78
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.
79
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.
80
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.
81