Ch. 28: The Distribution of
Income and Poverty
Del Mar College
John Daly
©2003 South-Western Publishing, A Division of Thomson Learning
Who Are the Rich And How Rich
Are They?
• The lowest fifth (lowest
quintile) of households is
considered poor, the top fifth
is considered rich, and the
three-fifths in between are
considered middle income.
• The income distribution in
the United States was less
equal (more unequal) in
1998 than in 1967.
SOURCE: U.S. Bureau of the Census.
Income Distribution, 1967 and 1998
SOURCE: U.S. Bureau of the Census.
Income Distribution and
Computers
•
•
Some people think that computers explain the
increasing income inequity.
Problems with this theory are:
1. The increasing income inequality precedes the use of
personal computers.
2. Just because income inequality and the use of
computers occur at about the same time, it does not
follow that one causes the other.
3. Some economists have found that wages and income
inequality increased with the use of pencils, but no
one is willing to make the case that pencils can shift
the income distribution.
Can All People Become Better
Off as the Income Distribution
Becomes More Equal?
• An increasingly unequal
income distribution is not
necessarily a sign of an
income group being worse
off.
• It is possible for everyone
to be better off at the same
time that the income
distribution becomes more
unequal.
The Income Distribution
Adjusted For Taxes And In-Kind
Transfer Payments
• Government can change the distribution of income
through the use of taxes and transfer payments.
• Ex ante distribution of income is the before tax
and/or transfer payment distribution of income.
• Ex post distribution of income is the after-tax-andtransfer-payment distribution of income.
• Transfer payments are payments to persons that
are not made in return for goods and services
currently provided.
The Effect of Age on the Income
Distribution
It is possible that a person in her late
twenties, thirties, or forties will have a
higher income than another person in her
early twenties or sixties, even though their
total lifetime income will be identical.
A Simple Equation
• Individual Income = Labor income + Asset
income + Transfer payments – Taxes
• Labor income is equal to the wage rate an
individual receives times the number of
hours he or she works.
• Asset income consists of such things as the
return to saving, the return to capital
investment, and the return to land.
Q&A
• How can government change the distribution of
income?
• Income inequality at one point in time is
sometimes consistent with income equality over
time. Comment.
• Smith and Jones have the same income this year,
$40,000. Does it follow that their income came
from the same sources? Explain your answer.
The Lorenz Curve
The Lorenz curve
represents the
distribution of income;
it expresses the
relationship between
cumulative percentage
of households and
cumulative percentage
of income.
A Hypothetical
Lorenz Curve
The data in (a) were used to derive the Lorenz curve in (b).
The Lorenz curve shows the cumulative percentage of income
earned by the cumulative percentage of households. If all
households received the same percentage of total income, the
Lorenz curve would be the line of perfect income equality.
The bowed Lorenz curve shows an unequal distribution of
income. The more bowed the Lorenz curve is, the more
unequal the distribution of income.
Lorenz Curve for the United
States, 1998
The Gini Coefficient is a
measurement of the
degree of inequality in the
income distribution.
The Gini Coefficient is equal
to the Area between line
of perfect income equality
and the actual Lorenz
Curve, divided by the
Entire Triangular are
under the line of perfect
income equality.
A Gini Coefficient of 0 is
complete income equality
while a Gini Coefficient
of 1 means complete
income inequality.
The Gini
Coefficient
A Limitation of the Gini
Coefficient
• The Gini Coefficient
cannot tell us what is
happening in different
quintiles.
• We should not jump to the
conclusion that because
the Gini coefficient is
lower in country 2 than in
country 21, the lowest
fifth of households have a
greater percentage of total
income, in country 2, than
in country 1.
By itself the Gini coefficient
cannot tell us anything about
the income share of a
particular quintile. Although
there is a tendency to believe
that the larger percentage of
total income the lower the
Gini coefficient, this need not
be the case.
In the
diagram, the Gini coefficient
for Lorenz curve 2 is lower
than the Gini coefficient for
Lorenz curve 1. But the
bottom 20 % of households
obtains a smaller percentage
of total income in the lower
Gini Coefficient case.
A Limitation of the
Gini Coefficient
Q&A
• Starting with the top fifth of income earners
and proceeding to the lowest fifth, suppose
the income share o9f each group is 40%,
30%, 20%, 10%, and 5%. Can these
percentages be right?
• Country A has a Gini coefficient of 0.45.
What does that mean?
Why Does Income Inequality
Exist?
Because people do not
receive the same labor
income, asset income,
and transfer payments,
or pay the same taxes.
Factors Contributing to Income
Inequality
• Innate Abilities and Attributes: Individuals are
not all born with the same abilities and qualities.
• Work and Leisure: There is a tradeoff between
work and leisure: More work means less leisure,
less work means more leisure.
• Education and Other Training: Generally, this is
human capital – the education, the development of
skills, and anything else that is particular to the
individual and increases his or her productivity.
Factors Contributing to Income
Inequality, Part II
• Risk Taking: Individuals have different attitude towards
risk.
• Luck: When individuals can’t explain why something
has happened to them, they often say it was the result of
good or bad luck. In the long run, such factors as innate
ability and attributes, education, and personal decisions
are more likely to have a larger sustained effect on
income than good or bad luck.
• Wage Discrimination: This exists when individuals of
equal ability and productivity, as measured by their
marginal revenue products, are paid different wage rates
by the same employer.
Income Differences: Voluntary
and Involuntary
• Some argue that wage
discrimination would be
lessened if markets were
allowed to be more
competitive, more open,
and more free.
• Others contend that even
if the government were to
do this, wage
discrimination would still
exist in vast quantities.
Q&A
• Jack and Harry work for the same company,
but Jack earns more than Harry. Is this
evidence of wage discrimination? Explain
your answer.
• A person decides to assume a lot of risk in
earning an income. How could this affect
his or her income? Why?
Normative Standards of Income
Distribution
• The marginal Productivity theory of factor
prices states that in a competitive setting
people tend to be paid their marginal
revenue products.
• The marginal productivity normative
standard of income distribution holds that
people should be paid their marginal
revenue products.
Different
Normative
Standards of
Income
Distribution
The Marginal Product Normative
Standard
• Some argue it is just for individuals to
receive their contribution to the productive
process and individuals should be paid their
marginal revenue products.
• Critics argue that some persons are innately
more productive than others and that
rewarding them for innate qualities is unfair.
The Absolute Income Equality
Normative Standard
Some hold that an equal distribution of income will
lead to the maximization of total utility in society.
Here’s the argument:
1. Individuals are alike when it comes to how much
satisfaction they receive from an added increase in
income.
2. Receiving additional income is subject to the law of
diminishing marginal utility.
3. Redistributing income from the rich to the poor will raise
total utility since the poor will gain more utility than the
rich will lose.
The Absolute Income Equality
Normative Standard, Part II
Opponents say it is
impossible to know if all
individuals receive equal
utility from an added
dollar of income, and
that a rich person may
receive far more utility
from an added dollar of
income than a poor
person receives.
Rawlsian Normative Standard
• John Rawls states that individuals will be more
likely to argue for a different income distribution
if they know what their position is in the current
income distribution than if they don’t know what
their position is in the current income distribution.
• Rawls created the “Veil of Ignorance” – an
imaginary veil or curtain behind which a person
did not know his or her position in the income
distribution.
Criticism of Rawls
• Individuals behind the veil of ignorance might not
reach a consensus on the income distribution that
should exist, and they might not be risk avoiders
to the degree Rawls assumes they will be.
• The size of the income pie might change given
different income distributions.
• Individuals are likely to consider this information
to a greater degree than Rawls assumes they will.
Poverty
• Poverty exists when the income of a family of four is
less than $10,000 per year.
• In relative terms, poverty exists when the income of a
family of four places it in the lowest 10 percent of
income recipients.
• The US Government defines poverty in absolute terms:
$16,600 per year for a family of four; $8,480 per year
for an individual under the age of 65; $7,818 per year
for an individual over the age of 65. This is called the
Poverty Income Threshold, commonly known as the
Poverty Line.
Limitations of the Official
Poverty Income Statistics
• The poverty figures are based solely on money
incomes. Many money-poor persons receive inkind benefits.
• Poverty figures are not adjusted for unreported
income, leading to an overestimation of poverty.
• Poverty figures are not adjusted for regional
differences in the cost of living, leading to both
overestimates and underestimates of poverty.
• Government counters are unable to find some poor
persons: illegal aliens and some of the homeless
which leads to an underestimation of poverty.
Poverty in Different Groups of the
Population.
All data are for 1998
SOURCE: U.S. Bureau of the Census.
Who Are The Poor?
• Although the poor are persons of all religions,
colors, genders, ages, and ethnic backgrounds,
some groups are represented in greater number
than others.
• A greater percentage of families headed by
females are impoverished, when compared to
percentages of families headed by males.
• Families with seven or more persons are more
likely to be impoverished than families with fewer
than seven members.
What is the Justification for
Government Redistributing Income?
• Some say a government should not play “Robin
Hood”. These people are against a government
using its powers to take from some and give to
others.
• Proponents of the Public Good – Free Rider
justification say:
• Most individuals in society would feel better if
there were little or no poverty; therefore, there is a
demand to reduce poverty.
Government Redistributing
Income? (Cont.)
• The reduction or elimination of poverty is a
nonexcludable public good, a good that if
consumed by one person can be consumed by
other persons to the same degree and the
consumption of which cannot be denied to anyone.
• If no one can be excluded from experiencing the
benefits of poverty reduction, then individuals will
not have any incentive to pay for what they can
get for free.
Social Insurance?
The Social Insurance
justification is a different
type of justification for
government welfare
assistance. Individuals
currently not receiving
welfare think they might
one day need welfare
assistance and thus are
willing to take out a form
of insurance for
themselves by supporting
welfare programs.
Q&A
• “Poor people will always exist.” Comment.
• What percentage of the U.S. population was
living in poverty in 1998?
• In 1998, what age category had the largest
percentage of its group living in poverty?