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© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair

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Prepared by: Fernando Prepared by: Fernando Quijano and Yvonn QuijanoQuijano and Yvonn Quijano

Income DistributionIncome Distributionand Povertyand Poverty


The Utility Possibilities FrontierThe Utility Possibilities Frontier

• The The utility possibilities utility possibilities frontierfrontier is a graphic is a graphic representation of a two-representation of a two-person world that shows all person world that shows all points at which A’s utility points at which A’s utility can be increased only if B’s can be increased only if B’s utility is decreased.utility is decreased.


The Utility Possibilities FrontierThe Utility Possibilities Frontier

• Any point inside the Any point inside the utility possibilities utility possibilities frontierfrontier is inefficient. At is inefficient. At point A, both I and J point A, both I and J could be better off.could be better off.

• Point B is preferable to Point B is preferable to point A.point A.

• Both B and C are Both B and C are efficient, but may not efficient, but may not be equally desirable.be equally desirable.


The Sources of Household IncomeThe Sources of Household Income

• Households derive their incomes Households derive their incomes from three basic sources:from three basic sources:

1.1. from wages or salaries received in from wages or salaries received in exchange for laborexchange for labor

2.2. from property—that is, capital, land, from property—that is, capital, land, and so forth; andand so forth; and

3.3. from government.from government.


Wages and SalariesWages and Salaries

• All factors of production are paid a All factors of production are paid a return equal to their marginal return equal to their marginal revenue product—the market value revenue product—the market value of what they produce at the margin.of what they produce at the margin.

• The rewards of a skill that is limited The rewards of a skill that is limited in supply depend on the demand for in supply depend on the demand for that skill. People with rare skills can that skill. People with rare skills can make enormous salaries.make enormous salaries.


Wages and SalariesWages and Salaries

• Human capitalHuman capital is the stock of is the stock of knowledge, skills, and talents that people knowledge, skills, and talents that people possess; it can be inborn or acquired possess; it can be inborn or acquired through education and training.through education and training.

• Compensating differentialsCompensating differentials are are differences in wages that result from differences in wages that result from differences in working conditions. Risky differences in working conditions. Risky jobs usually pay higher wages; highly jobs usually pay higher wages; highly desirable jobs usually pay lower wages.desirable jobs usually pay lower wages.


Income from PropertyIncome from Property

• Property incomeProperty income is income derived is income derived from ownership of real property and from ownership of real property and financial holdings. It takes the form financial holdings. It takes the form of profits, interest, dividends, and of profits, interest, dividends, and rents.rents.

• The amount of property income that The amount of property income that a household earns depends on:a household earns depends on:

1.1. how much property it owns, andhow much property it owns, and

2.2. what kinds of assets it owns.what kinds of assets it owns.


Income from GovernmentIncome from Government

• Transfer paymentsTransfer payments are payments are payments by the government to people who do by the government to people who do not supply goods or services in not supply goods or services in exchange.exchange.

• Transfer programsTransfer programs are part of the are part of the government’s attempts to offset government’s attempts to offset some of the problems of inequality some of the problems of inequality and poverty.and poverty.


The Distribution of IncomeThe Distribution of Income

• Economic incomeEconomic income is the amount of is the amount of money a household can spend money a household can spend during a given period without during a given period without increasing or decreasing its net increasing or decreasing its net assets.assets.

• Wages, salaries, dividends, interest Wages, salaries, dividends, interest income, transfer payments, rents, income, transfer payments, rents, and so forth are sources of economic and so forth are sources of economic income.income.


Income Inequality in the United StatesIncome Inequality in the United States

Distribution of Total Income and Components in the United States, 1997 Distribution of Total Income and Components in the United States, 1997 (Percentages)(Percentages)

HOUSEHOLDSHOUSEHOLDSTOTAL TOTAL

INCOMEINCOMEWAGES AND WAGES AND

SALARIESSALARIESPROPERTY PROPERTY

INCOMEINCOMETRANSFER TRANSFER

INCOMEINCOME

Bottom fifthBottom fifth 6.06.0 5.75.7 1.01.0 27.627.6

Second fifthSecond fifth 9.19.1 11.911.9 4.04.0 26.126.1

Third fifthThird fifth 14.714.7 19.919.9 8.48.4 18.718.7

Fourth fifthFourth fifth 23.623.6 27.327.3 16.416.4 13.913.9

Top fifthTop fifth 46.646.6 35.235.2 70.270.2 13.713.7

Top 1 percentTop 1 percent 10.010.0 3.23.2 29.729.7 1.51.5Source:Source: Brookings Merge File and authors’ estimates. Brookings Merge File and authors’ estimates.


Money IncomeMoney Income

• Money incomeMoney income is a measure of the is a measure of the income used by the Census Bureau. income used by the Census Bureau. Because it excludes noncash Because it excludes noncash transfer payments and capital gains transfer payments and capital gains income, it is less inclusive than income, it is less inclusive than “economic income.”“economic income.”


Changes in the Distribution of IncomeChanges in the Distribution of Income

Distribution of Money Income of U.S. Families by Quintiles, 1947 – 1997 Distribution of Money Income of U.S. Families by Quintiles, 1947 – 1997 (Percentages)(Percentages)

19471947 19601960 19721972 19801980 19841984 19941994 19971997

Bottom fifthBottom fifth 5.05.0 4.84.8 5.45.4 5.25.2 4.74.7 4.24.2 4.24.2

Second fifthSecond fifth 11.811.8 12.212.2 11.911.9 11.511.5 11.011.0 10.010.0 9.99.9

Third fifthThird fifth 17.017.0 17.817.8 17.517.5 17.517.5 17.017.0 15.715.7 15.715.7

Fourth fifthFourth fifth 23.123.1 24.024.0 23.923.9 24.324.3 24.424.4 23.323.3 23.023.0

Top fifthTop fifth 43.043.0 41.341.3 41.441.4 41.541.5 42.942.9 46.946.9 47.247.2

Top 5 percentTop 5 percent 17.217.2 15.915.9 15.915.9 15.315.3 16.016.0 20.120.1 20.720.7Source: Statistical Abstract of the United StatesSource: Statistical Abstract of the United States, various editions; Department of Commerce, HHES Division., various editions; Department of Commerce, HHES Division.


The Lorenz CurveThe Lorenz Curve

• The The Lorenz curveLorenz curve is a widely is a widely used graph of the distribution of used graph of the distribution of income, with cumulative income, with cumulative percentage of families plotted percentage of families plotted along the horizontal axis and along the horizontal axis and cumulative percentage of income cumulative percentage of income plotted along the vertical axis.plotted along the vertical axis.


The Lorenz CurveThe Lorenz Curve

• If income is equally If income is equally distributed, there is no distributed, there is no shaded area.shaded area.

• More unequal More unequal distributions of income distributions of income produce Lorenz Curves produce Lorenz Curves that are farther from the that are farther from the 45-degree line.45-degree line.


The Gini CoefficientThe Gini Coefficient

• The The Gini coefficientGini coefficient is a commonly used is a commonly used measure of inequality measure of inequality of income derived of income derived from a Lorenz Curve. from a Lorenz Curve. It can range from zero It can range from zero (maximum equality) to (maximum equality) to a maximum of 1 a maximum of 1 (maximum inequality).(maximum inequality).


Differences Between African-American Differences Between African-American Households, White Households, and Single-Households, White Households, and Single-

Person HouseholdsPerson Households

Distribution of Money Income of Households, 1997 (Percentages)Distribution of Money Income of Households, 1997 (Percentages)

ALLALLHOUSEHOLDSHOUSEHOLDS

AFRICAN-AFRICAN-AMERICANAMERICAN

HOUSEHOLDSHOUSEHOLDSWHITEWHITE

HOUSEHOLDSHOUSEHOLDSHISPANICHISPANIC

HOUSEHOLDSHOUSEHOLDSONE-PERSONONE-PERSONHOUSEHOLDSHOUSEHOLDS

0-10,0000-10,000 11.011.0 21.421.4 9.59.5 16.816.8 25.425.4

10-15,00010-15,000 8.18.1 10.510.5 7.87.8 10.710.7 15.815.8

15-25,00015-25,000 14.914.9 17.917.9 14.614.6 19.719.7 20.720.7

25-35,00025-35,000 13.313.3 14.214.2 13.213.2 15.015.0 14.014.0

35-50,00035-50,000 16.316.3 14.914.9 16.516.5 16.616.6 11.611.6

50-75,00050-75,000 18.118.1 13.113.1 18.818.8 12.212.2 7.77.7

75,000 +75,000 + 18.418.4 7.97.9 19.719.7 9.19.1 4.74.7

TotalTotal 100.0100.0 100.0100.0 100.0100.0 100.0100.0 100.0100.0Note:Note: Totals may not add to 100 due to rounding. Totals may not add to 100 due to rounding.Source: Statistical Abstract of the United StatesSource: Statistical Abstract of the United States, 1999, Tables 742 and 744., 1999, Tables 742 and 744.


PovertyPoverty

• In simplest terms, In simplest terms, povertypoverty is the is the condition of people who have very condition of people who have very low incomes.low incomes.

• The The poverty linepoverty line is the officially is the officially established income level that established income level that distinguishes the poor form the distinguishes the poor form the nonpoor. It is set at three times the nonpoor. It is set at three times the cost of the Department of cost of the Department of Agriculture’s minimum food budget.Agriculture’s minimum food budget.


Poverty in the United StatesPoverty in the United StatesSince 1960Since 1960

Percentage of Persons in Poverty by Demographic Group, 1964 - 1997Percentage of Persons in Poverty by Demographic Group, 1964 - 1997

OFFICIALOFFICIALMEASUREMEASURE

19641964

OFFICIALOFFICIALMEASUREMEASURE

19641964

ADJUSTED FORADJUSTED FORIN-KIND TRANSFERSIN-KIND TRANSFERS

AT MARKET VALUE, 1997AT MARKET VALUE, 1997aa

AllAll 19.019.0 13.313.3 10.010.0

WhiteWhite 14.914.9 11.011.0 8.48.4

African-AmericanAfrican-American 49.649.6 26.526.5 19.319.3

HispanicHispanic NANA 27.127.1 19.619.6

Female householder – Female householder – no husband present no husband present 45.945.9 35.135.1 NANA

Elderly (65+)Elderly (65+) 28.528.5 10.510.5 NANA

Children under 18Children under 18 20.720.7 19.919.9 NANAaaIncludes food, housing, and medical benefits.Includes food, housing, and medical benefits.Source: Statistical Abstract of the United StatesSource: Statistical Abstract of the United States, 1999, Tables 760, 763, 766, and 770., 1999, Tables 760, 763, 766, and 770.


The Distribution of WealthThe Distribution of Wealth

• The distribution of wealth is much The distribution of wealth is much more unequal than the distribution of more unequal than the distribution of income. Wealth is passed from income. Wealth is passed from generation to generation and generation to generation and accumulates.accumulates.

• Some argue that unequal distribution Some argue that unequal distribution of wealth is a natural consequence of wealth is a natural consequence of risk taking in a market economy.of risk taking in a market economy.


The Distribution of WealthThe Distribution of Wealth

Percentage of Different Assets Owned by Households, 1998 Percentage of Different Assets Owned by Households, 1998 Survey of Survey of Consumer FinancesConsumer Finances

PERCENTAGE OF PERCENTAGE OF OWNERSOWNERS

COMMON STOCK COMMON STOCK EXCLUDING EXCLUDING PENSIONSPENSIONS

ALL ALL COMMON COMMON

STOCKSTOCKNONEQUITY NONEQUITY

FINANCIAL ASSETSFINANCIAL ASSETSHOUSING HOUSING EQUITYEQUITY

NET NET WORTHWORTH

Top .5 percentTop .5 percent 41.441.4 37.037.0 24.224.2 10.210.2 25.625.6

Top 1 percentTop 1 percent 53.253.2 47.747.7 32.032.0 14.814.8 34.034.0

Top 10 percentTop 10 percent 91.291.2 86.286.2 72.272.2 50.750.7 68.968.9

Bottom 80 percentBottom 80 percent 1.71.7 4.14.1 14.014.0 29.329.3 18.518.5

Source:Source: James Poterba, “Stock Market Wealth and Consumption,” James Poterba, “Stock Market Wealth and Consumption,” Journal of Economic Perspectives,Journal of Economic Perspectives, 14(2), 99 – 118 , Spring 2000. 14(2), 99 – 118 , Spring 2000.


The Redistribution DebateThe Redistribution Debate

• Philosophical arguments against Philosophical arguments against redistribution:redistribution:

• The market, when left to operate on its The market, when left to operate on its own, is fair. “One is entitled to the fruits own, is fair. “One is entitled to the fruits of one’s efforts.”of one’s efforts.”

• Taxation of income for redistribution Taxation of income for redistribution purposes is against “freedom of contract” purposes is against “freedom of contract” and the protection of property rights.and the protection of property rights.



• Practical arguments against Practical arguments against redistribution:redistribution:

• Taxation and transfer programs interfere Taxation and transfer programs interfere with the incentives to work, save, and with the incentives to work, save, and invest.invest.

• Bureaucratic waste and inefficiency is Bureaucratic waste and inefficiency is inevitable in the administration of social inevitable in the administration of social programs.programs.



• Arguments in favor of redistribution:Arguments in favor of redistribution:

• A wealthy country, such as the United A wealthy country, such as the United States, has the moral obligation to States, has the moral obligation to provide all its members with the provide all its members with the necessities of life. The Constitution does necessities of life. The Constitution does carry a guarantee of the “right to life.”carry a guarantee of the “right to life.”




• Utilitarian justiceUtilitarian justice is the idea that “a is the idea that “a dollar in the hand of a rich person is dollar in the hand of a rich person is worth less than a dollar in the hand of a worth less than a dollar in the hand of a poor person.” If the marginal utility of poor person.” If the marginal utility of income declines with income, transferring income declines with income, transferring income from the rich to the poor will income from the rich to the poor will increase total utility.increase total utility.




• Rawlsian justiceRawlsian justice is a theory of is a theory of distributional justice that concludes that distributional justice that concludes that the social contract emerging from the the social contract emerging from the “original position” would call for an “original position” would call for an income distribution that would maximize income distribution that would maximize the well-being of the worst-off member of the well-being of the worst-off member of society.society.


The Works of Karl MarxThe Works of Karl Marx

• Marx did not write very much about Marx did not write very much about socialism or communism.socialism or communism.

• He wrote a critique of capitalism, but He wrote a critique of capitalism, but was not very clear about what would was not very clear about what would replace it.replace it.

• In one essay he wrote, “from each In one essay he wrote, “from each according to his ability, to each according to his ability, to each according to his needs.”according to his needs.”


The Works of Karl MarxThe Works of Karl Marx

• The The labor theory of valuelabor theory of value, stated , stated most simply, is the theory that the most simply, is the theory that the value of a commodity depends only value of a commodity depends only on the amount of labor required to on the amount of labor required to produce it.produce it.

• The owners of capital are able to The owners of capital are able to extract “surplus value” out of labor.extract “surplus value” out of labor.


Redistribution Programs and PoliciesRedistribution Programs and Policies

• The income tax is The income tax is progressiveprogressive—those with higher incomes —those with higher incomes pay a higher percentage of their incomes in taxes.pay a higher percentage of their incomes in taxes.

Effective Rates of Federal, State, and Local Taxes, Effective Rates of Federal, State, and Local Taxes, 2000 (Taxes as a Percentage of Total Income)2000 (Taxes as a Percentage of Total Income)

Bottom 20%Bottom 20% 34.034.0 %%

Second 20Second 20 31.231.2

Third 20Third 20 32.332.3

Fourth 20Fourth 20 32.632.6

Top 20Top 20 33.933.9

Top 10Top 10 34.534.5

Top 5Top 5 34.934.9

Top 1Top 1 37.037.0Source:Source: Authors’ estimate. Authors’ estimate.


Expenditure ProgramsExpenditure Programs

• The The Social Security systemSocial Security system is a federal is a federal system of social insurance programs. It system of social insurance programs. It includes three separate programs that are includes three separate programs that are financed through separate trust funds:financed through separate trust funds:

• the Old Age and Survivors Insurance (OASI) the Old Age and Survivors Insurance (OASI) program,program,

• the Disability Insurance (DI) program, andthe Disability Insurance (DI) program, and

• the Health Insurance (HI, or Medicare) the Health Insurance (HI, or Medicare) program.program.



• Public assistancePublic assistance, or , or welfarewelfare, consists , consists of government transfer programs that of government transfer programs that provide cash benefits to:provide cash benefits to:

1.1. families with dependent children whose families with dependent children whose incomes and assets fall below a very low incomes and assets fall below a very low level, andlevel, and

2.2. the very poor, regardless of whether or not the very poor, regardless of whether or not they have children.they have children.



• The The Supplemental Security Income Supplemental Security Income (SSI)(SSI) program is designed to take care of program is designed to take care of the elderly who end up very poor.the elderly who end up very poor.

• Unemployment compensationUnemployment compensation is a state is a state government transfer program that pays government transfer program that pays cash benefits for a certain period of time cash benefits for a certain period of time to laid-off workers who have worked for a to laid-off workers who have worked for a specified period of time for a covered specified period of time for a covered employer.employer.



• MedicaidMedicaid and and MedicareMedicare are in-kind are in-kind government transfer programs that government transfer programs that provide health and hospitalization provide health and hospitalization benefits:benefits:

• Medicare to the aged and their survivors and Medicare to the aged and their survivors and to certain of the disabled, regardless of to certain of the disabled, regardless of income, and Medicaid to people with low income, and Medicaid to people with low incomes.incomes.



• Food stampsFood stamps are vouchers that have a face are vouchers that have a face value greater than their cost and that can be value greater than their cost and that can be used to purchase food at grocery stores.used to purchase food at grocery stores.

• Housing programsHousing programs are designed to improve the are designed to improve the quality of life for low-income people.quality of life for low-income people.

• The The Earned Income Tax CreditEarned Income Tax Credit is an important is an important program that allows lower income families with program that allows lower income families with children a credit equal to a percentage of all children a credit equal to a percentage of all wage and salary income against their income wage and salary income against their income taxes.taxes.

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Ch15

Education