Economics 10 1 2017 September Lecture 18 Chapter 19 Income Inequality 2017 Economics 101 CCC

content Income inequality defined Methods to review income inequality

Income inequality

Income inequality - basics Inequality measures the disparity between a percentage of population and the percentage of resources (such as income) received by that population. If a single person holds all of a given resource, inequality is at a maximum. If all persons hold the same percentage of a resource, inequality is at a minimum. Inequality studies explore the levels of resource disparity and their practical and political implications.

Why measure income inequality?

Why measure income inequality?

Why measure income inequality?

Why measure income inequality? economic efficiency: experience of socialist countries, where deliberately low inequality deprived people of incentives - low initiative among workers, poor quality and limited selection of goods and services, slow technical progress, and eventually, slower economic growth leading to more poverty. people’s quality of life: leading to a higher incidence of poverty, impeding progress in health and education, and contributing to crime.

Why measure income inequality? Employment resources: a country deprives itself of the contributions the poor could make to its economic and social development. Political stability: people are dissatisfied with their economic status, which makes it harder to reach political consensus and increases the risks of investing in a country and so significantly undermines its development potential. Basic norms of behavior among economic agents: trust and commitment decreases and thus higher business risks and higher costs of contract enforcement. Social justice: high levels of income inequality tend to strike many people as unfair, especially when they imply starkly different opportunities available to children born in the same country

Why measure income inequality? Sociopolitical Instability

Why measure income inequality? Look for and understand: Good inequality increase incentives for innovation, entrepreneurship and economic growth. Bad inequality creates obstacles for poor people to receive education and to access credit, that impediment economic development Measuring changes in inequality helps determine the effectiveness of policies aimed at affecting inequality and generates the data necessary to use inequality as an explanatory variable in policy analysis.

Measuring income inequality Lorenz curve, gini coefficient & income distribution

Measuring Economic Inequality Definitions of income Market income equals wages, interest, rent, and profit earned in factor markets before paying income taxes. Total income equals market income plus cash payments to households by governments. After-tax income equals total income minus tax payments by households to governments. .

Method for measuring income inequality Lorenz curve Gini coefficient

Measuring Economic Inequality Lorenz Curve Lorenz curve was developed by Max O. Lorenz in 1905 as a graphical representation of income distribution. Lorenz curve portrays observed income distributions and compares this to a state of perfect income equality.

Measuring Economic Inequality Lorenz Curve % of Income 3 9 15 24 49 % of Households Lowest 20% Second 20% Middle 20% Fourth 20% Richest 20% This model shows the distribution of income across households in an economy. It is a rough guide to the extent of inequalities that may exist.

Measuring Economic Inequality Lorenz Curve On the y-axis we show the cumulative percentage of income 100 80 60 40 20 % of Income If all households earned an equal share of the total income then a 45° line would be plotted. On the x-axis we show the cummulative percentage of households. 20 40 60 80 100 % of Households

Measuring Economic Inequality Lorenz Curve The further the Lorenz curve is from the diagonal line (perfect equality of income), the more inequality of income exists in an economy

Canadian Lorenz Curve Example 53.1% Ex: 20% of Canadians received 4.1% of income; 40% got 13.8%. E C 29.4% B 13.8% A 4.2% 15.3% = Percent below Statistics Canada low-income cut-off

Measuring Economic Inequality Lorenz Curve: USA Example A Lorenz Curve for the U.S., 1929, 1970, and 2007 Cumulative % of income 20 Cumulative % of Families 60 80 100 40 From 1929 to 1970, income inequality decreased Line of absolute equality From 1970 to 2007, income inequality increased 2007 1970 1929 20-22

Measuring Economic Inequality Lorenz Curve: Brazil & Hungary example Brazil’s Lorenz curve deviates from the hypothetical line of absolute equality much further than that of Hungary. This means that of these two countries Brazil has the higher income inequality

Measuring Economic Inequality Gini equation Measure of distribution inequality. Ratio of the area between the Lorenz Curve and the Line of Perfect Equality define a values called the Gini Coefficient number between 0 and 1 0 corresponds to perfect equality (i.e., everyone has the same income) and 1 corresponds to perfect inequality (i.e., one person has all the income, and everyone else has zero income). The larger the ratio, the more inequitable the distribution of income.

Measuring Economic Inequality Gini equation Gini coefficient, equals the ratio of blue area to the red area in the two figures below.

Measuring Economic Inequality Gini equation With perfect equality, the Lorenz curve is the line of equality and the Gini coefficient is zero.

Measuring Economic Inequality Gini equation With the most extreme inequality—one person has all the income—the Lorenz curve runs along the axes and the Gini coefficient is one.

Measuring Economic Inequality

Inequality in the World: Using the Gini Equation

Inequality in the World Economy Which countries have the greatest economic inequality? Which countries have the least and the greatest equality? Where does Canada rank? How much inequality is there in the world economy as a whole?

Inequality in the World: Example: Canada The Gini coefficient of total income in Canada has increased. 0.379 in 1980 0.395 in 1990 0.429 in 2005. In 2009, the Canadian Gini coefficient was 0.45. Means what .. More inequality .. Rich getting richer?? Canada had less inequality than the United States but gap is growing in both

Inequality in the World Economy Income Distributions in Selected Countries

Inequality in the World Economy

Inequality in the World Economy World Gini Ratio The global distribution of income is becoming less unequal. Despite individual countries becoming more unequal, incomes in poorer countries are rising faster than incomes in rich countries.

Causes of Inequality Individual National

Individual Ownership of resources – housing, land, etc. Qualifications/Education Motivation Skills Ability Family size Luck

National Factor of production (land, labour, capital) Size and quality of labour force Climate Stage of economic development Economic Markets Land Locked Nations Governance & Civil War

Methods of Income Redistribution

Income Redistribution The three main ways governments redistribute income are Income taxes Income maintenance programs Subsidized services

Income Redistribution Income Taxes The Canadian federal government and provincial governments tax incomes. By taxing incomes of different levels at different tax rates, economic inequality can be decreased. The Canadian income tax system is a progressive income tax system. progressive income tax

Income Redistribution Income Maintenance Programs Three major types of programs, which redistribute income by making direct payments to individuals, are Social security Employment insurance Welfare

Income Redistribution Subsidized Services Services provided by the government at prices below the cost of production. taxpayers who consume these goods and services receive a transfer in kind from the taxpayers who do not consume them. Ex: education—both kindergarten through Grade 12 and college and university health care.

Income Redistribution Income Distribution is a Big Tradeoff Income Distribution supports greater equity but creates inefficiency How are inefficiencies created? Income redistribution uses up resources that could have otherwise been used for producing goods and services. Redistribution of income requires taxes to be imposed and taxes generate a deadweight loss. Income redistribution decreases the incentives for … Taxpaying workers to provide labour when leisure is a normal good (by decreasing income from work) and Recipients of income assistance to provide labour and earn an income.

questions What is income inequality and how it is measured? Any challenges with this measure? Is this topic related to trade? Efficiency? Government actions? Is it necessarily a bad thing for the Gini Coefficient to increase over time? Equity and efficiency

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