Transcript Ch10

A Lecture Presentation
in PowerPoint
to accompany
Exploring Economics
by Robert L. Sexton
and Peter Fortura
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
Chapter 10
Input Markets and the
Distribution of Income
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10.1 Input Markets


Approximately 70 percent of national
income goes to wages and salaries for
labour services.
The rest goes to owners of land and
capital and the entrepreneurs who
employ those resources to produce
valued goods and services.
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10.1 Input Markets



The price and quantity of each of these
inputs is determined by their supply and
demand.
In input or factor markets, the demand
for an input is a derived demand—
derived from consumers’ demand for
the good or service.
The “price” of a productive factor is
directly related to consumer demand for
the final good or service.
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10.2 Supply and Demand in the
Labour Market


Because firms are trying to maximize
their profits, they try to make the
difference between total revenue and
total cost as large as possible.
The attractiveness of a resource, then,
varies with what the resource can add
to the revenues received by the firm
relative to what it adds to costs.
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10.2 Supply and Demand in the
Labour Market


The demand for labour is determined by
its marginal revenue product (MRP),
which is the additional revenue that a
firm obtains from one more unit of input.
The marginal resource cost (MRC) is
the amount that an extra input adds to
the firm’s total costs. In a competitive
labour market, its MRC is the market
wage.
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10.2 Supply and Demand in the
Labour Market


A firm would find its profits growing by
adding one more worker when the
marginal revenue product associated
with the worker exceeds the marginal
resource cost of the worker.
However, additional hiring would be
unprofitable when the marginal resource
cost exceeds the marginal revenue
product.
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10.2 Supply and Demand in the
Labour Market


The demand curve for labour is
downward sloping.
Higher wages will decrease the quantity
of labour demanded, while lower wages
will increase the quantity of labour
demanded.
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10.2 Supply and Demand in the
Labour Market

The major reason for the downwardsloping demand curve for labour is the
law of diminishing marginal product.


As increasing quantities of labour are
added to fixed quantities of another input,
output will rise, but at some point it will
increase by diminishing amounts.
The added output associated with one
more worker—marginal product—declines
as more workers are added and each has
fewer fixed resources with which to work.
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Marginal Revenue Product
The Marginal Revenue
Product of Labour
Marginal Revenue Product
(demand curve for labour)
0
Quantity of labour
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Diminishing Marginal Productivity
On A Hypothetical Farm
Units of
labour Input
(workers)
Total Wheat
Output
(bushels per year)
Marginal
Product of labour
(bushels per year)
0
1
2
3
4
5
6
7
3000
5500
7000
8000
8500
8800
9000
3000
2000
1500
1000
500
300
200
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10.2 Supply and Demand in the
Labour Market

The marginal revenue product (MRP) is
the change in total revenue associated
with an additional unit of input.
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10.2 Supply and Demand in the
Labour Market


The marginal revenue product is equal
to the marginal product (the units of
output added by a worker) multiplied by
the marginal revenue (in the competitive
output market case, this is price of the
output).
The marginal revenue product of labour
declines because of the diminishing
marginal product of labour.
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Marginal Revenue Product, Output, and
Labour Inputs
Marginal
Product Price
Marginal
Wage Rate
Quantity
Total Output
Product of labour (dollars per
Revenue
(MRC)
of labour(bushels per week) (bushels per week)
bushel) Product of labour (dollars per week)
0
1
2
3
4
5
6
7
8
0
100
190
270
340
400
450
490
520
100
90
80
70
60
50
40
30
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$10
10
10
10
10
10
10
10
$1000
900
800
700
600
500
400
300
$550
550
550
550
550
550
550
550
10.2 Supply and Demand in the
Labour Market

Profits are maximized if a firm hires only
to the point where
Wage = expected marginal revenue
product.
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10.2 Supply and Demand in the
Labour Market



The firm will hire up to the last unit of
input for which the marginal revenue
product is expected to exceed the
wage.
Therefore, value of the marginal
revenue product (MRP) is the same as
the demand curve for labour for a
competitive firm.
It is why raising wages, ceteris paribus,
lowers employment.
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10.2 Supply and Demand in the
Labour Market


In a competitive labour market, many
firms are competing for workers and no
single firm is big enough by itself to
have any significant effect on the level
of wages.
The firm is a wage taker.
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10.2 Supply and Demand in the
Labour Market

The ability to hire all you wish at the
prevailing wage is analogous to perfect
competition in output markets, where a
firm could sell all it wanted at the going
price.
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The Competitive Firm’s Hiring Decision
b. Firm’s Supply and Demand for labour
Wage Rate
Market Demand
of labour
W*
Wage Rate
a. Market Supply and Demand for labour
Firm’s labour
Supply (MRC)
W*
Market Demand
for labour
0
Q*
Quantity of labour
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0
Firm’s Labour
Demand (MRP)
q*
Quantity of labour
10.2 Supply and Demand in the
Labour Market

Just as the case in the law of supply, a
positive relationship exists between
wage level and the quantity of labour
supplied.


As the wage rate rises, the quantity of
labour supplied increases, ceteris paribus.
As the wage rate falls, the quantity of
labour supplied falls, ceteris paribus.
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The Market Supply Curve of Labour
Wage Rate
S
B
W1
W0
A
Q0
Q1
Quantity of labour
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10.3 Labour Market Equilibrium

At any wage higher than the
equilibrium wage,
the quantity of labour supplied
exceeds the quantity of labour
demanded, resulting in a surplus of
labour;
 unemployed workers will be willing to
undercut the established wage in
order to get jobs, pushing the wage
down and returning the market to
equilibrium.

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10.3 Labour Market Equilibrium

At a wage below the equilibrium
level,
quantity demanded would exceed
quantity supplied, resulting in a labour
shortage;
 employers would be forced to offer
higher wages in order to hire as many
workers as they would like.

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10.3 labour Market Equilibrium

Only at the equilibrium wage are both
suppliers (workers) and demanders
(employers) able to exchange the
quantity of labour they desire.
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Wage Rate
Supply and Demand in the Labour Market
QS > QD
S
QD > QS
D
W1
W*
W2
0
Q*
Quantity of labour
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10.3 Labour Market Equilibrium


Two important factors can shift the
demand curve for labour.
Increases in the demand curve for
labour may arise from


increases in labour productivity or
increases in the price of the good, due,
for example, to increases in the demand
for the firm’s product.
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Shifts in the LabourCurve
D0
0
b. Decrease in labour Demand
Wage Rate
Wage Rate
a. Increase in labour Demand
D1
D1
Quantity of labour
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.
0
D0
Quantity of labour
10.3 Labour Market Equilibrium

Workers can increase productivity if



they have more capital or land with which
to work;
technological improvements occur;
they acquire additional skills or experience.
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10.3 Labour Market Equilibrium


This increase in productivity will
increase the marginal product of labour
and shift the demand curve for labour to
the right.
However, if labour productivity falls,
then marginal product will fall and the
demand curve for labour will shift to the
left.
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10.3 Labour Market Equilibrium

The greater the demand for the firm's
product, the greater the firm’s demand
for labour or any other variable input.
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10.3 Labour Market Equilibrium


Higher demand for the firm's product
increases the firm's marginal revenue,
which increases marginal revenue
product.
If demand for the firm's product falls, the
labour demand curve will shift to the left,
as marginal revenue product falls.
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10.3 Labour Market Equilibrium

Several factors can cause the labour
supply curve to shift,




immigration and population growth,
the number of hours workers are willing to
work at a given wage (worker tastes or
preferences),
nonwage income,
amenities.
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10.3 Labour Market Equilibrium


If new workers enter the labour force, it
will shift the labour supply curve to the
right.
If there are fewer workers in the labour
force, it will cause the labour supply
curve to shift to the left.
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10.3 Labour Market Equilibrium


If people become willing to work more
hours at a given wage (due to changes
in worker tastes or preferences), the
labour supply curve will shift to the right.
If they become willing to work fewer
hours at a given wage, the labour
supply curve will shift to the left.
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10.3 Labour Market Equilibrium


Increases in income from other sources
than employment can cause the labour
supply curve to shift to the left.
A decrease in nonwage income might
push a person back into the labour
force, thus shifting the labour supply
curve to the right.
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10.3 Labour Market Equilibrium



If there are amenities associated with a
job, it will make for a more desirable
work atmosphere, ceteris paribus.
These amenities would cause an
increase, or rightward shift, in the
supply of labour.
If job conditions deteriorate, it would
lead to a reduction, or leftward shift, in
the labour supply curve.
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10.4 Labour Unions


Labour unions are formed to increase
their members’ wages and to improve
working conditions.
Workers realize that acting together, as
a union of workers, gives them more
collective bargaining power than acting
individually.
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10.4 Labour Unions



Union membership in Canada has
approximately 3.9 million members.
This constitutes about 30% of the 12.8
million workers.
Wide variations in union rates
contribute to structural shifts in
occupations of Canadian workers
Provinces have differing rates of
unionization (Newfoundland- 39% and
Alberta 22%) which also contribute.
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10.4 Labour Unions


Unionization efforts have been
particularly successful in the public
sector rather than the private sector.
However, unions have traditionally
found it difficult to organize workers in



white-collar jobs (professional, scientific)
in agriculture, and
in technical and hospitality
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10.4 Labour Unions

Labour unions influence the quantity of
union labour hired and the wages at
which they are hired primarily through
their ability to alter the supply of labour
services to employers from what would
exist if workers acted independently.
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10.4 Labour Unions

By restricting membership or available
manpower, unions reduce the quantity of
labour supplied, and increase wages in that
occupation.
 Union workers will now receive higher
wages; others will become unemployed.
 Many economists believe that this is why
wages are approximately 15 percent higher
in union jobs, even when nonunion workers
have comparable skills.
 Some of these gains will go to unions as
dues, initiation fees, etc.
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S1
S0
W1
W0
Wage Rate
Wage Rate
The Effect of Unions on Wages
S0
W0
W2
D
0
Q1 Q0
Quantity of Labour
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.
S1
D
0
Q0 Q1
Quantity of Labour
10.4 Labour Unions


If unions are successful in obtaining
higher wages, that will also cause
employment to fall in the union sector.
With a downward-sloping demand curve
for labour, higher wages mean that less
labour is demanded in the union sector.
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10.4 Labour Unions


Those workers who are equally skilled
but are unable to find union work will
seek nonunion work, thus increasing
supply in that sector and, in turn,
lowering wages in the nonunion sector.
Thus, comparably skilled workers will
experience higher wages in the union
sector than in the nonunion sector.
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10.4 Labour Unions

Some argue unions might actually
increase worker productivity by



providing a collective voice to
communicate workers’ discontents
effectively.
lower number of exits, which is costly for
firms
by handling worker’s grievances, may
increase workers’ motivation and morale.
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10.4 Labour Unions

While it appears that unions tend to
lower the profitability of firms, not raise it
they do play a larger role in the lives of,
and consequently benefit, individuals
previously marginalized in the
workplace. (women and minorities)
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10.5 Land and Rent


Economic rent is the price paid for land
or any other factor that has a fixed
supply—a perfectly inelastic supply
curve.
The supply of land is perfectly inelastic
and not at all responsive to prices.
There will be as much land available at
a zero price as at a very high price.
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10.5 Land and Rent



The price of using land—its rental
price—is determined by demand and
supply considerations.
Changes in the demand for land will
change the rental value.
Because the supply curve is completely
inelastic, the demand curve determines
the price of the land.
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10.5 Land and Rent


If demand is high, the rental price of
land is high; if demand is low, the rental
price of land is low.
Only changes in the demand for land
will change the price of land.
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Price of Land (R)
Supply and Demand in the Land Market
S
RH
DHigh
RL
0
DLow
Q
Quantity of Land
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10.5 Land and Rent

The demand for land is derived from the
demand for the products being
produced.


If supply is fixed, an increase in demand
for the output raises the output price.
This in turn raises the demand and rents
for land, due to its greater marginal
revenue product as a factor of production.
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10.5 Land and Rent



The concept of economic rent does not
only apply to land.
It is a very powerful tool to
understanding labour.
Differences between productive
resources give rise to variations in
productivity and thus to variations in
compensation.
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10.5 Land and Rent

Labour resources that are in highly
limited supply and in great demand will
command a large amount in
compensation.

People who receive income because of a
distinct, unique skill are collecting
economic rent—compensation for a
resource whose supply is perfectly inelastic
over the relevant range of prices.
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10.5 Land and Rent

Examples




star athletes,
famous surgeons, and
music stars,
Nearly every resource owner has some
ability of skill that allows him to earn at
least a little economic rent.
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10.6 Capital and Interest


Resources like capital can be “leased”
or “rented” for some stipulated period of
time.
Following the law of demand,



the lower the rental price of a machine,
the lower the cost of production when
using it, and
the greater the quantity of machines
demanded.
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10.6 Capital and Interest

Following the law of supply,
 the greater the rental price of
machines,
 the more willing owners of those
machines are to supply them to
entrepreneurs.
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10.6 Capital and Interest


The price of borrowed funds is called
the interest rate.
At lower interest rates,



the cost of financing the purchase of a
machine is lower;
capital costs are lower;
the quantity of funds demanded is greater.
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10.6 Capital and Interest


The lenders of funds will derive greater
income the greater the interest rate, so
the benefits to them of making a loan
increase as interest rates (the price of
funds) rise.
Thus, the quantity of funds supplied is
positively related to interest rates.
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10.6 Capital and Interest

The intersection of the upward-sloping
supply curve for capital and the
downward-sloping demand curve for
capital determines the price of capital.
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Rental Price of Capital
The Supply and Demand For Capital Goods
S
P
D
0
Q
Quantity of Capital
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10.6 Capital and Interest



A firm making an investment decision
must consider the price of the new
capital that they must pay now with the
additional revenue the firm anticipates
to make over time.
That is, the firm must compare current
cost with future benefits.
To figure out how much those future
benefits are worth today, economists
use a concept called present value.
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10.6 Capital and Interest



The present value of future income is
the value of having that future income
now.
People prefer to have money now rather
than later; that is why they are willing to
pay interest to borrow it.
PV = $X / (1 + r)t
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10.6 Capital and Interest



Because the discount rate varies from
person to person, a good proxy is the
market rate of interest.
An investor will buy capital if the
expected discounted present value of
the capital exceeds the current price.
Therefore, falling interest rates lead to
greater investment.
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.
Present Value Table
Year
3%
6%
8%
1
0.9709
0.9434
0.9259
2
1.9135
1.8334
1.7833
3
2.8286
2.6730
2.5771
4
3.7171
3.4651
3.3121
5
4.5797
4.2124
3.9927
6
5.4172
4.9173
4.6229
7
6.2303
5.5824
5.2064
8
7.0197
6.2098
5.7466
9
7.7861
6.8017
6.2469
10 8.5302
7.3601
6.7101
11
9.2526
7.8869
7.1390
12 9.9540
8.3838
7.5361
13 10.6350
8.8527
7.9038
14 11.2961
9.2950
8.2442
15 11.9379
9.7122
8.5595
16 12.5611
10.1059
8.8514
17 13.1661
10.4773
9.1216
18 13.7535
10.8276
9.3719
19 14.3238
11.1581
9.6036
20 14.8775
11.4699
9.8181
30 a division
19.6004
Copyright © 2007, Nelson,
of Thomson13.7648
Canada Ltd. 11.2578
.
10%
0.9091
1.7355
2.4869
3.1699
3.7908
4.3553
4.8684
5.3349
5.7590
6.1446
6.4951
6.8137
7.1034
7.3667
7.6061
7.8237
8.0216
8.2014
8.3649
8.5136
9.4269
15%
0.8696
1.6257
2.2832
2.8550
3.3522
3.7845
4.1604
4.4873
4.7716
5.0188
5.2337
5.4206
5.5831
5.7245
5.8474
5.9542
6.0472
6.1280
6.1982
6.2593
6.5660
Year
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
30
10.6 Capital and Interest



We have treated the labour, capital, and
land markets independently.
In reality, these markets are
interdependent.
For example, if wages rise and/or the
rental price of capital falls, machines
might be substituted for some workers.
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10.7 Income Distribution



The ultimate purpose of producing
goods and services is to satisfy the
material wants of people.
But for whom does society produce
consumer goods and services?
Why are some people able to consume
much more than others?
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Mean Household Income by Quintile
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10.7 Income Distribution


While there have been changes in the
distribution of measured income, there
remains substantial income inequality.
Inequality might be overstated due to
failure to consider differences in




age,
certain demographic factors,
institutional factors,
and government redistributive activities.
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10.7 Income Distribution

At any moment in time, middle-age
persons tend to have higher incomes
than younger and older persons
because


they are at an age when their productivity
is at a peak and
they are participating in the labour force to
a greater extent.
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10.7 Income Distribution


Even if every individual earned exactly
the same income over his or her
lifetime, there would still be inequality at
any given moment in time, so that
inequality resulting from this overstates
the true inequality in the lifetime
earnings of people.
The increased proportion of Canadians
that are either very young or very old
has tended to increase the observed
inequality in the distribution of income.
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10.7 Income Distribution

Other demographic trends have also
caused the measured distribution of
income (measured in terms of
household or family income) to appear
more unequal.



increased number of divorced couples
rise of two-income families
DINKS (Double Income, No Kids)
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10.7 Income Distribution


A family that decides to have two bread
winners instead of one would move into
a higher income quintile and create
greater apparent income inequality.
At the same time, divorces create two
households instead of one, lowering
income per household for divorced
couples; thus, they move into lower
income quintiles, also creating greater
apparent income inequality.
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10.7 Income Distribution



The impact of increased government
activity should be considered in
evaluating the measured income
distribution.
Government-imposed taxes burden
different income groups differently.
Also, many government programs
benefit some groups of income
recipients more than others.
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10.7 Income Distribution

When taxes and in-kind income are
included, many economists conclude
that they have served to reduce levels
of inequality significantly from the levels
suggested by aggregate income
statistics.
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10.7 Income Distribution

However, if we consider age
distribution, institutional factors, and inkind transfer programs, it is safe to say
that the income distribution is
considerably more equal than it
appears.
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10.7 Income Distribution

While the distribution of current income
is an important piece of information, it is
also critical to know how much
movement goes on between different
income levels.

The people that make up a given income
group are not always the same people
because there is substantial movement
between income groups.
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.
10.7 Income Distribution

Reasons people differ in income

age
Wages generally increase up to the age of 50
and fall dramatically at retirement age.
 Younger people tend to make little income
when they begin their working careers.





skill
education
Training, discrimination,
preferences toward risk and leisure.
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10.7 Income Distribution




As productivity increases, workers can
command higher wages.
Some workers are just more productive
than others, as a result of both innate
skills and training and education.
Some workers’ skills are just more in
demand than others.
Those that work longer hours or more
intensely earn more.
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10.7 Income Distribution



Those who prefer more amenities at
work or more time for leisure earn less.
Those who work in riskier or more
unpleasant jobs earn more as
compensation.
Despite difficulties in measurement,
international comparisons of income
distribution have been made.
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10.8 Poverty

Our concern over income distribution
largely arises because of a feeling that
people with low incomes (“the poor”)
suffer in a material sense relative to
other persons.
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10.8 Poverty

Economic growth can have important effects
on poverty and welfare.
 Those most likely to be poor:
 Unattached individuals
 Single parent families headed by
females
 Less than a high school education
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10.8 Poverty

The evidence suggests



Income distribution in Canada has been
relatively stable since 1951.
That regardless of national wealth some
Canadians live in poverty
Economic factors contribute to this income
diversity.
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.
Low Income Cut-offs (2000)
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.
Incidence of Low Income by
Households (2000)
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.
10.8 Poverty

Statistics Canada measures poverty by
using a set of money income thresholds
that vary by family size and are adjusted
for inflation.


If the family’s total income is less than the
established threshold—the poverty line—it
is considered poor or below the Low
Income Cut Off. (LICO)
The poverty rate is the proportion of
persons who fall below that absolute
standard.
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10.8 Poverty

LICO for Canada is currently set at :





$24 186 for a family of four in a small city
$15 172 for a single person in a large city
LICO levels are defined by the percentage of
income used for necessities.
Households that spend 64% or more of after
tax dollars on shelter, food and clothing are
defined as poor.
The poverty rate may overstate the level of
poverty because it does not include noncash
benefits of some available public assistance.
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10.8 Poverty

With a definition of poverty that is
determined at some fixed, real income
level, poverty over time should decline
unless lower income groups do not
share at all in rising incomes because
real incomes generally rise over time
with economic growth.
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10.8 Poverty


Thus, one cure for poverty, as defined
by some absolute income or standard of
living criterion, is economic growth.
The greater the rate of economic
growth, the more rapidly poverty will be
reduced or eradicated.
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10.8 Poverty


Many “poor” individuals in Canada,
using the official definition, would be
considered well off, even “rich” in many
less-developed countries.
Rather than being classified by an
ability to buy some specific basket of
goods and services, poverty is often
thought of as a relative income concept.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
10.8 Poverty

A person is “poor” if his or her income is
low relative to the incomes of most
other persons in the same geographical
area.
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.
10.8 Poverty


Using definitions of poverty based on
relative income measures, as economic
growth proceeds, the income necessary
to avoid being considered poor by this
measure increases.
Using this definition, then, poverty
cannot be eradicated by economic
growth, but only by income
redistribution.
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