Income Distribution and Poverty Chapter 18 Income Distribution and Poverty Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e Economic Principles The Lorenz curve The Gini coefficient Rawls’s theory of justice Life cycle wealth The case for income equality Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e Economic Principles The case for income inequality Poverty thresholds Negative income tax Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Income Distribution and Poverty Questions about the rich and the poor arise from the political, ethical, economic and religious foundations of our society. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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? Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Income Distribution and Poverty These questions concerning income distribution haven’t changed much in the last 2,500 years. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Not Too Many Coal Miners Are Millionaires There are four forms of income: Wages Interest Rent Profit Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Not Too Many Coal Miners Are Millionaires People’s income increases or decreases as a result of these changes. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Measuring Income Distribution There are two principal ways to measure an economy’s income distribution: The Lorenz curve The Gini coefficient Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Measuring Income Distribution For example, if 20 percent of the people receive 20 percent of the income, then there is perfect income equality. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Measuring Income Distribution In reality all income distributions lie somewhere between perfect equality and perfect inequality. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e EXHIBIT 1 LORENZ CURVES FOR THE COM- MUNITIES OF WASHTENAU, SPRINGFIELD, AND HOLMES Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e 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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e EXHIBIT 2 LORENZ CURVES FOR SWEDEN, CHINA, BRAZIL, AND THE UNITED STATES Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e Exhibit 2: Lorenz Curves for Sweden, China, 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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Measuring Income Distribution Consider the champagne glass effect to explain world income distribution, divide the height of the glass (see Exhibit 3) into five segments or quintiles. The top and widest contains the income held by the richest—75 percent of the world’s income. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e EXHIBIT 3 WORLD INCOME DISTRIBUTION AND REGIONAL SHARES Source: Dikhanov 2005. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Exhibit 3: World Income Distribution and Regional Shares What does this exhibit prove about world income inequities? World income disparity between top and bottom is great. By region, the distribution of world income is skewed in favor of the high-income OECD. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Measuring Income Distribution The coefficient (G) is calculated as G = A/(A + B). Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e EXHIBIT 4 THE GINI COEFFICIENT Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Exhibit 4: The Gini Coefficient As the area represented by A in Exhibit 3 becomes smaller, the Gini coefficient becomes: i. Smaller ii. Larger Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Exhibit 4: The Gini Coefficient As the area represented by A in Exhibit 3 becomes smaller, the Gini coefficient becomes: i. Smaller ii. Larger Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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 2006 in the United States. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e EXHIBIT 5 SHARE OF AGGREGATE INCOME RECEIVED BY HOUSEHOLDS, BY QUINTILE AND TOP 5 PERCENT, AND GINI COEFFICIENT: 1970–2006 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); 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, 2001); U.S. Census Bureau, Housing and Household Economic Statistics, August 2007. . Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e Exhibit 5: Share of Aggregate Income Received by Households, by Quantile and Top 5 Percent, and Gini Coefficient: 1970–2006 How has the share of total income received by the top 5 percent changed in the U.S. since 1970? The top 5 percent received about 16 percent of the total income in 1970. By 2006, it had increased to over 22 percent. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e EXHIBIT 5 GINI COEFFICIENT FOR HOUSEHOLDS, BY RACE AND ETHNIC ORIGIN, 1970–2004 Source: U.S. Bureau of the Census, Housing and Household Economic Statistic Division, December 20, 2005. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e Exhibit 5: Gini Coefficient for Households, by Race and Ethnic Origin, 1970–2004 This table shows what pattern in the Gini coefficients within white, black, Asian, and Hispanic households? The pattern that income inequality grew within each racial or ethnic category? Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

How Unequal Is Our Income Distribution? The increase in income inequality seen in the U.S. is similar to the pattern in some developed countries, while other developed countries seem to be more egalitarian. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e EXHIBIT 6 GINI COEFFICIENTS FOR EUROPE, JAPAN, CANADA, AND AUSTRALIA (2005) Source: Human Development Report 2007–2008, United Nations Development Programme, 2008. . Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e Exhibit 6: Gini Coefficients for Europe, Japan, Canada, and Australia (2005) How does U.S. income distribution compare to that of other economies? U.S. income distribution is not only less equitable than in Europe, Canada, Japan, and Australia. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e EXHIBIT 7 INEQUALITY IN THE U.S. AND SELECTED EUROPEAN COUNTRIES, 1980–2005 Source: Standing Alone in Inequality, Bernard Waskow, The Century Foundation, in http://www.tcf.org/list.asp?type=NC&publid=1403. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e Exhibit 7: Inequality in the U.S. and Selected European Countries 1980–2005 By comparing U.S. income distribution to this selection of European countries, what do you see? Their Gini differences seem to be widening as well. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e EXHIBIT 8 WORLD MAP OF GINI COEFFICIENTS Source: UN Human Development Report 2007/2008. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Exhibit 8: World Map of Gini Coefficients Where can we see more dramatic differences among world income distribution patterns? The distributions for most of the developing economies of Asia, Africa, the Middle East, and Latin America as shown in Exhibit 8. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

How Unequal Is Our Income Distribution? Wealth The accumulated assets owned by individuals. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

How Unequal Is Our Income Distribution? Life-cycle wealth Wealth in the form of nonmonetary assets, such as a house, automobiles, and clothing. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

How Unequal Is Our Income Distribution? Wealth represents the accumulated assets of a lifetime, including inherited assets. Wealth tends to be far more unevenly distributed than income. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e EXHIBIT 9 EQUALITY AND MAXIMUM UTILITY Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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, how-ever, the poor may still be better off. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e EXHIBIT 10 EFFECT OF INEQUALITY ON NATIONAL INCOME Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e EXHIBIT 11 INEQUALITY AND ECONOMIC GROWTH Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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). Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Do We Have to Live with Poverty? Poverty threshold The level of income below which families are considered to be poor. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e EXHIBIT 12 PERCENTAGE OF PERSONS BELOW THE POVERTY LEVEL, BY RACE, 1960–2005 NA = not available * Refers to data for 1959 Source: Bureau of the Census, Statistical Abstract of the United States, 2008 (Washington, D.C.; Department of Commerce, 2008), p. 459. . Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e Exhibit 12: Percentage of Persons Below the Poverty Level, by Race, 1960–2005 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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Fighting the War on Poverty Cash assistance Government assistance in the form of cash. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Fighting the War on Poverty In-kind assistance Government assistance in the form of direct goods and services, such as Medicaid or food stamps. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e EXHIBIT 13 CASH AND NONCASH BENEFITS FOR PERSONS OF LIMITED INCOME: 2005 Source: Statistical Abstract of the United States, 2008 (Washington, D.C.: Department of Commerce, 2008, p. 309. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e Exhibit 13: Cash and Noncash Benefits for Persons with Limited Income: 2005 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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

The Negative Income Tax Alternative 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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Gottheil — Principles of Economics, 7e EXHIBIT 14 THE NEGATIVE INCOME TAX APPLIED (TAX = 50%) Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Exhibit 14: 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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Exhibit 14: 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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning

Exhibit 14: 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. Gottheil — Principles of Economics, 7e © 2013 Cengage Learning