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8/11/2019 Ch19 10e Lecture GE
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19ECONOMIC
INEQUALITY
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Extreme poverty and extreme wealth exist side by side inevery major city in the United States and in most parts of the
world.
How many rich and poor people are there in the UnitedStates?
How does the distribution of income in the United Statescompare with that in other countries?
Are the rich getting richer and the poor getting poorer?
Or are incomes becoming more equal?
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The census bureau defines a households income as
money income, which equals market income plus cashpayments to households by the government.
Market incomeequals wages, interest, rent, and profitearned by the household in factor markets, before payingincome taxes.
Economic Inequality in the
United States
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The Distribution of
Income
Figure 19.1 shows the
distribution of incomeacross the 117.5 millionhouseholds in theUnited States in 2009.
Economic Inequality in the
United States
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The modeincome is themost common income andwas about $22,000.
The medianincome is thelevel of income thatseparates the populationinto two groups of equalsize and was $49,777.
The meanincome is theaverage income and was$67,976.
Economic Inequality in the
United States
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A distribution in whichthe mean exceeds themedian and the median
exceeds the mode ispositively skewed, whichmeans it has a long tailof high values.
The U.S. distribution ofincome is positivelyskewed.
Economic Inequality in the
United States
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Figure 19.2 showsthe distribution ofincome shares for
the United States in2009.
Economic Inequality in the
United States
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In 2009:
The poorest 20% ofhouseholds receivedonly 3.4% of the total
income.
The middle 20%received 14.6% of
total income.The richest 20%received 50.2% oftotal income.
Economic Inequality in the
United States
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Economic Inequality in the
United States
The Income Lorenz Curve
The income Lorenz curvegraphs the cumulative
percentage of incomeearned against thecumulative percentage ofhouseholds.
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The vertical axis plots thecumulative percentage ofincome.
The horizontal axis is the
cumulative percentage ofhouseholds.
Economic Inequality in the United
States
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Economic Inequality in the United
States
If everyone has the sameincome,
the income Lorenz curve
is a 45 degree line fromthe lower left corner tothe upper right corner.This line is called the lineof equality.
The Lorenz curve showsthe distribution of income.
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The Distribution of
Wealth
A households wealthis
the value of all thethings that it owns at apoint in time.
The distribution ofwealth is another way ofexamining the degree ofeconomic inequality.
Economic Inequality in the
United States
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A wealth Lorenz curvemeasures thedistribution of wealth.
The distribution ofwealth is even moreunequally distributedthan income.
Economic Inequality in the
United States
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Wealth or Income?
Wealth is a stock of assets and income is a flowofearnings that result from a given stock of wealth.
Wealth is more unequally distributed than income becausewealth does notmeasure the quantity of human capital.
Income reflects the quantity of human capital.
Because the distribution of wealth excludes human capital,the distribution of income is a more accurate measure ofeconomic inequality.
Economic Inequality in the
United States
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Annual or Lifetime Income and Wealth?
A households income and wealth change over time.
A household headed by a young person starts out withmoderate income and accumulates wealth for retirementyears.
A middle-age headed household is in its highest income
years and enjoys the highest level of wealth.
A households headed by an older, retired person haslower income and is consuming, rather than accumulating,its wealth.
Economic Inequality in the
United States
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Trends in Inequality
To measure inequality as an index number, we use theGini ratio, which equals the ratio of blue area to the red
area in the two figures below.
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United States
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With perfect equality, the Lorenz curve is the line ofequality and the Gini ratio is zero.
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United States
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With the most extreme inequalityone person has all theincomethe Lorenz curve runs along the axes and theGini ratio is one.
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United States
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The closer the Gini ratio is to one, the more unequal is thedistribution of income.
In 2009, the U.S. Gini ratio was a bit more than 0.46.
Economic Inequality in the
United States
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Figure 19.5 shows theU.S. Gini ratio from 1970to 2009.
The Gini ratio shows thatthe distribution of incomein the United States hasbecome more unequal.
Despite the change inthe definition in 1992, thetrend is still visible.
Economic Inequality in the
United States
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Poverty
Povertyis a situation in which a households income istoo low to be able to buy the quantities of food, shelter,
and clothing that are deemed necessary.
Poverty is a relative concept.
In 2009, the poverty level calculated by the Social Security
Administration for a four-person family was $21,756.
44 million Americans lived in households with incomesbelow this poverty level14 percent of the total populationin 2009.
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United States
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The distribution of poverty by race is unequal:
In 2009, 9.4 percent of white Americans lived in povertycompared to 25 percent of Hispanic-origin Americans and
26 percent of African Americans.
Poverty is also influence by household status:
More than 28 percent of households in which the
householder is a female with no husband present hadincomes below the poverty level.
Despite the widening of the income distribution, povertyrates have fallen.
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States
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Inequality in the World Economy
Which countries have the greatest economic inequality?
Which countries have the least and the greatest equality?
Where does the United States rank?
How much inequality is there in the world economy as awhole?
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Inequality in the World Economy
Income Distributions inSelected Countries
Figure 19.6 illustratessome extremes and the
U.S. Lorenz curves.
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Inequality in the World Economy
Global Inequality and Its Trends
The global distribution of income is much more unequalthan the distribution within any one country.
Of the world population:
50 percent live on $2.50 a day or less; 30 percent live onbetween $2.50 and $10 a day.
That is, 80 percent of the world population is very poor.
The average American has $115 a day.
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Inequality in the World Economy
World Gini Ratio
The global distribution ofincome is becoming less
unequal.
Despite individual countriesare becoming moreunequal, incomes in poorercountries are rising fasterthan incomes in richcountries.
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The Sources of Economic Inequality
Inequality arises from unequal labor market outcomes andfrom unequal ownership of capital.
Three significant features of labor markets contribute to
income differences among individuals:
Human capital
Discrimination
Contest among superstars
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Human Capital
The more human capital a person possesses, the moreincome that person likely earns, other things remaining the
same.
On the demand side of the labor market, high-skilledworkers generate a larger value of marginal product thanlow-skilled workers.
So firms are willing to pay a higher wage rate for high-skilled labor.
The Sources of Economic Inequality
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On the supply side of the labor market, high-skilledworkers incur a cost of acquiring their skillsmoney costsas well as time costs.
So high-skilled workers are willing to supply labor only atwage rates that compensate them for those costs.
The supply of high-skilled workers is smaller than thesupply of low-skilled workers.
The Sources of Economic Inequality
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Trends in InequalityExplained
Technological change
Computers and laserscanners are substitutesforlow-skilled labor.
The demand for low-skilled
labor has decreased and thewage rate has fallen.
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New technologies and high-skilled labor arecomplements.
The demand for high-skilledlabor has increased and thewage rate has risen.
The gap between the wagerates of high- and low-skilledlabor has increased.
The Sources of Economic Inequality
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The Sources of Economic Inequality
Globalization
The entry of China and other developing countries into theglobal economy has lowered the prices of manufactured
goods and decreased the value of marginal product oflabor.
The demand for low-skilled labor has decreased and theirwage rate has fallen.
But a growing global economy has increased the demandfor high-skilled workers and their wage rate has risen.
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Discrimination
Human capital differences can explain some of theeconomic inequality we observe.
Discrimination is another possible source of incomeinequality.
If the value of marginal product of one sex (or race) is
perceived to be higher than that of another sex (or race),the equilibrium wage rates will vary across the gender (orracial) groups, despite holding human capital constant.
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Suppose that firms perceive white males to be moreproductive workers than black females.
Then the perceived value of marginal product of white
men would be higher than that of black women.
The demand for labor of white men is higher than thedemand for labor of black women.
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Figure 19.9 shows thepotential effect ofdiscrimination of whitemen and black women.
If black women arediscriminated against, theperceived VMPis lower.
Their wage rate andemployment leveldecrease.
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If white men arediscriminated for, theperceived VMPis higher.
Their wage rate andemployment levelincrease.
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Counteracting Forces
Economists disagree to the extent that discriminationpervades the labor market.
One line of reasoning states: Firms that discriminate wouldhave higher production costs (pay higher wages for thesame VMP) than those that do not.
If this line of reasoning is correct, firms practicingdiscrimination will have
1. Smaller profits margins.
2. Higher market prices.
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Either way, market pressures increase the opportunity costto firms for practicing discrimination, eventually eliminatingthese practices.
Differences in the Degree of Specialization
Another line of reasoning is that:
sex discrimination can be explained by differences
between the men and women regarding their willingness,on average, to specialize in earning a wage versus doingjobs in the home.
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More women than men work at home for a portion of theiradult life while engaged in child rearing and/or running thehousehold.
This allocation of time means that womens wages will belower, on average, than mens wages.
Accounting for this difference in labor specialization hasbeen found to explain much of the wage differentials
between men and women.
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Do Contests Among Superstars Explain the Trend?
Contests among superstars can explain large differencesin incomes.
Globalization has increased the market reach of thewinner in a winner-take-all contest and increased thespread between the winner and the runner up.
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Unequal Wealth
The inequality of wealth (excluding human capital) is muchgreater than the inequality of income.
This greater wealth inequality arises from two sources:
1. Life-cycle saving patterns
2. Transfers of wealth between generations
The significant aspects of intergenerational wealthtransfers that increase economic inequality is thatmarriage concentrates wealth.
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Income Redistribution
The three main ways governments in the United Statesredistribute income are
Income taxes
Income maintenance programs
Subsidized services
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Income Taxes
The U.S. federal government and most state governmentstax incomes.
By taxing incomes of different levels at different tax rates,economic inequality can be decreased.
A progressive income taxis one that taxes income at an
average rate that increases with income.
The U.S. income tax system and all state income taxsystems are progressive income tax systems.
Income Redistribution
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A regressive income taxis one that taxes income at anaverage rate that decreases with income.
A proportional income tax(also called a flat-rate income
tax) is one that taxes income at a constant average ratefor all income levels.
Income Redistribution
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Income Maintenance Programs
Three major types of programs provide direct payments toindividuals:
Social Security programs
Unemployment compensation
Welfare programs
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Subsidized Services
A great deal of redistribution takes the form of subsidizedservicesservices provided by the government at pricesbelow the cost of production.
An example is primary and secondary public education, aswell as state colleges and universities.
The students at these institutions generally pay tuition and
fees that range from 20 to 25% of the actual cost ofeducating a college student.
The families of these students enjoy a sizeable subsidy foracquiring human capital.
Income Redistribution
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The Big Tradeoff
Redistributing income leads to a tradeoff between equityand efficiency, known as the big tradeoff.
Programs to redistribute income are inefficient for threereasons:
1. Income redistribution uses up resources that could have
otherwise been used for producing goods and services.2. Redistribution of income requires taxes to be imposed
and taxes generate a deadweight loss.
Income Redistribution
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3. Income redistribution decreases the incentives for
Taxpaying workers to provide labor when leisure is anormal good (by decreasing income from work) and
Recipients of income assistance to provide labor andearn an income.
A Major Welfare Challenge
To find ways to assist the poorest identifiable group:Young minority women who have not completed highschool, have dependent children, and live without apartner in the household.
Income Redistribution
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The long-term solution to their plight is education and jobtrainingacquiring human capital.
The short-term solution is enforcing child support
payments from absent fathers and former husbands, andproviding welfare assistance.
But it must be designed to minimize the disincentive tobecome self-sufficient.
Income Redistribution
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The Personal Responsibility and Work OpportunitiesReconciliation Act of 1996 increased the penalties fornonpayment of support.
The Act also created the Temporary Assistance for NeedyFamilies (TANF) program.
TANF is a block grant to the states, not an open-endedentitlement program for individuals.
An adult member of a family receiving assistance musteither work or perform community service and there is afive-year limit for receiving assistance.
Income Redistribution