© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko “The Economic Way of Thinking” 11 th Edition Chapter 11: The Distribution of Income

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 2 of 46 Chapter 11 Outline Introduction Suppliers and Demanders Capital and Human Resources Human Capital and Investment Property Rights and Income Actual, Legal and Moral Rights

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 3 of 46 Chapter 11 Outline Expectations and Investment People or Machines? The Derived Demand for Productive Services Who Competes Against Whom? Unions and Competition

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 4 of 46 Chapter 11 Outline Poverty and Inequality Why Inequality is Increasing Redistributing Income Changing Rules and Social Cooperation

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 5 of 46 Introduction Our money incomes come from other people. We supply what other people want. Thus, the distribution of income simply results from supply and demand.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 6 of 46 Suppliers and Demanders Income –Is not actually distributed –Is the outcome of numerous interacting decisions –Decisions can be unfair The Distribution of Income –Is the product of the supply and demand for productive services

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 7 of 46 Suppliers and Demanders Productive Services –Productive means the same as demanded. –Services does not necessarily mean that effort has been expended. The distribution of income depends on the prior distribution of wealth.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 8 of 46 Suppliers and Demanders Question –What is wealth? Wealth includes ownership of human capital.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 9 of 46 Capital and Human Resources Capital is produced goods that can be used to produce future goods. This includes machinery, and the knowledge and skills of labor.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 10 of 46 Capital and Human Resources US Income Inequality –Arises primarily from unequal abilities to supply valuable human services. US Income –Most is earned by supplying the services of human resources.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 11 of 46 Human Capital and Investment People add to their stock of human capital by investing in their personal skills.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 12 of 46 Property Rights and Income Productive resources are owned, individually and jointly, by many people using a variety of arrangements Property rights depend on the reigning rules of the game.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 13 of 46 Property Rights and Income Questions –Do you “own” your driveway even if you cannot prevent someone from blocking its entrance? –What value does an education have if you cannot use it due to lack of a license to practice the skill?

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 14 of 46 Property Rights and Income Questions –Does the owner of an apartment complex whose rents are controlled actually own the apartments? –Does a mayor own any of the city’s facilities?

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 15 of 46 Actual, Legal and Moral Rights Actual Rights – control expectations and behavior Legal Rights – government regulated Moral Rights – what one believes one ought to enjoy

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 16 of 46 Expectations and Investment Decisions about the use of resources depend upon expectations. Investment Decisions –Based on the assessment of the relative values expected from consumption and investment.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 17 of 46 Expectations and Investments Annual Income Age of Income Recipient Lawyers Mechanic Lifetime Income Profiles

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 18 of 46 People or Machines? Questions –Do machines “destroy” jobs? –What does it mean to say “machines are more productive”? When will a machine replace a person? –If the marginal revenue from the machine’s use relative to its marginal cost is greater than the ratio for a person.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 19 of 46 People or Machines? Are wage rates relevant? Technology innovations release labor to do other tasks Some people do experience a loss in wealth after a reallocation of labor.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 20 of 46 The Derived Demand for Productive Services Derived Demand –The demand for productive services is derived from the demand for the goods they produce. Quantity of services demanded depends upon: –The demand for the good being produced. –The wage rates of the service providers.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 21 of 46 The Derived Demand for Productive Services Demand as a Constraint –The income of owners of productive resources is limited by the demand for those services. Demand as a Constraint –The income of owners of productive resources is created by the demand for the services of those resources.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 22 of 46 Who Competes Against Whom? OPEC (and similar organizations) –Argues that their association will allow them to better compete with Buyers. However, Buyers and Sellers do not compete. –Buyers compete to obtain what Sellers produce. –Sellers compete to sell their product to Buyers.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 23 of 46 Who Competes Against Whom? Example –Assigning the exclusive right to an athlete’s services through the draft. Question –This arrangement is designed to reduce competition between whom?

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 24 of 46 Unions and Competition Questions –Are workers at the mercy of employers regarding pay? –Do we need unions to even the playing field?

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 25 of 46 Unions and Competition Wages –Employers bid for workers’ services. –Workers cannot insist on receiving higher wages if other similar workers will work for less.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 26 of 46 Unions and Competition Unions attempt to control competition among workers. Contract wages will exclude those who would work for a lower wage. May limit competition by limiting membership.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 27 of 46 Unions and Competition Unions –History does not support the argument that unions arose to counter the power of the large corporations.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 28 of 46 Poverty and Inequality Employment opportunities are eliminated by enforcement of high wages. Income cannot be greater than output. Reducing poverty is not the same as reducing inequality.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 29 of 46 Poverty and Inequality Percentage of Aggregate Income Earned by Each Quintile--Families Lowest 5th Second 5th Middle 5th Fourth 5th Highest 5th Highest 5% It should be noted that the families in the top quintile supply four times as many weeks as families in the bottom quintile.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 30 of 46 Poverty and Inequality Figures –Do include money transfers. –Do not include in-kind transfers. –Do not account for differing family sizes. Poverty –Has been substantially reduced. –Inequality has only been modestly reduced.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 31 of 46 Poverty and Inequality Percentage of Families with Incomes Below the Poverty Line

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 32 of 46 Poverty and Inequality Poverty Line –Income households of various sizes need to live decently. –Three times the income required to purchase an adequate diet. –Adjusted annually. –Economic growth has led to the decrease in the poverty rate.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 33 of 46 Poverty and Inequality Defining Poverty –Absolutely –Relatively Family income depends significantly upon the age of the principal income earner. –As we grow older, we move into different quintiles.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 34 of 46 Poverty and Inequality Family Mean Incomes in to 24 years$36, to 34 years56, to 44 years70, to 54 years82, to 64 years74, years and over45,713 Age of HouseholderMean Income

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 35 of 46 Why Inequality is Increasing 80% of US family income = worker’s wages The number of high school graduates exceeds the number of college graduates entering labor force. –Thus, increased wage inequality.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 36 of 46 Why Inequality is Increasing Demand for Labor –Manufacturing sector has been decreasing in size. Pay is relatively equal. –Service sector has been increasing in size. Pay is relatively unequal.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 37 of 46 Redistributing Income Question –Is it the same thing to say: Too much income inequality is undesirable? Poverty is undesirable? Question –How much income inequality is desirable? How to reallocate? –Taxes and subsidies?

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 38 of 46 Redistributing Income Raising Taxes on High Incomes –Government must change the rules. –People adjust their behaviors to minimize the impact of the new rules. Avoidance Evasion

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 39 of 46 Redistributing Income Raising the Income of the Poor –Government must rewrite the rules for grants. –People adjust their behavior to fit the new rules.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 40 of 46 Redistributing Income Raising the Income of the Poor –Sometimes it isn’t worth working. Income is taxed Day care Clothing Transportation to work Loss of government subsidies

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 41 of 46 Redistributing Income Marginal Tax Rate –The percentage of additional income taken by the tax collector.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 42 of 46 Changing Rules and Social Cooperation Why not keep changing the rules until the desired outcome is attained? –Who has the knowledge? –Changing rules would destroy the foundation for most social cooperation.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 43 of 46 Once Over Lightly The distribution of income is the result of supply and demand for productive services. The production of productive resources is investment, or the creation of capital. One important form of capital is human capital. Property rights establish the amount and nature of the investment that will occur in a society.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 44 of 46 Once Over Lightly Lower rates of time preference encourage investment over consumption The demand for productive services of any kind will not be perfectly inelastic. The quantity of resources demanded is determined by comparing MR and MC. The demand for productive services is derived from the demand for the goods they produce.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 45 of 46 Once Over Lightly Suppliers of productive services do not compete against buyers of those services. Economic growth has dramatically reduced poverty in the US during the first ¾ of the 20 th century. The last ¼ of the century was marked by small, steady increases in income inequality. Social cooperation requires stable property rights.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 46 of 46 End of Chapter 11 Questions?