Questions/ Comments

Midterm Answer Key

Q3

Evaluations

Office Hours:
Monday and Wednesday

4:30PM-5:30PM
12-1
CHAPTER 12
INCOME
REDISTRIBUTION:
CONCEPTUAL
ISSUES
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
The Distribution of Income Among Households
Percentage Share
Year
Lowest
Fifth
Second
Fifth
Middle
Fifth
Fourth
Fifth
Highest
Fifth
Top 5
Percent
1967
4.0
10.8
17.3
24.2
43.6
17.2
1977
4.2
10.2
16.9
24.7
44.0
16.8
1982
4.0
10.0
16.5
24.5
45.0
17.0
1987
3.8
9.6
16.1
24.3
46.2
18.2
1992
3.8
9.4
15.8
24.2
46.9
18.6
1997
3.6
8.9
15.0
23.2
49.4
21.7
2002
3.5
8.8
14.8
23.3
49.7
21.7
2004
3.4
8.7
14.7
23.2
50.1
21.8
Source: U.S. Census Bureau, Current Population Survey, Annual Social and Economic Supplements
URL: http://www.census.gov/hhes/www/income/histinc/h02ar.html
These figures do not include the value of in-kind transfers.
12-3
Income Distribution

Important?

Economists vs. Policy Makers
12-4
Who is Poor?
Group
All persons
Poverty Rate
Group
Poverty
Rate
12.7%
Under 18 years
17.8%
White
8.4
Black
22.8
Hispanic
origin
20.5
65 years and
older
9.8
Female
households,
no husband
present
28.4
Source: US Bureau of the Census, “Historical Poverty Tables.”
[WWW Document] URL: http://www.census.gov/prod/2005pubs/p60-229.pdf
Figures are for 2004.
12-5
Measuring Poverty

Poverty Line

A fixed level of real income considered enough to
provide a minimally adequate living.

$18,400 in 2003

Cost for Basket of Goods (Adjusted for
Inflation)

Basket Does Not Change!

New Basket in 2000

120% Increase
12-6
Poverty Rate (1960-2004)
Figure 12.1: Poverty rate (1960-2004)
25%
20%
15%
10%
5%
0%
1960
1964
1968
1972
1976
1980
1984
1988
1992
1996
2000
2004
Source: US Bureau of the Census, “Historical Poverty Tables.”
[WWW Document] URL: http://www.census.gov/hhes/www/poverty/histpov/hstpov2.html
12-7
Interpreting the Distributional Data


Taxes Ignored
Annual Income



Consumption Data
Units of Observation


Cyclical
Households
Census = Cash Receipts


Ignores in-kind transfers
Decrease 12.7% to 8.3%
12-8
Nonindividualistic Views

Income Distribution is Personal Preference


Incomes distributed equally as matter of principle
Commodity Egalitarianism

In-Kind Transfers
12-9
Expenditure Incidence

Relative Price Effects


Public Goods Problem


More Expensive?
Values
Valuing In-Kind Transfers

$1 Spent by Gov = $1 to BC?
12-10
Other goods per month
In-kind Transfers
420
H
E3
340
A
F
300
260
U
E1
20 60
B
150
D
210
Pounds of cheese per month
12-11
Other goods per month
In-kind Transfers
420
H
A
F
300
E5
168
E4
136
82
126
B
150
D
210
Pounds of cheese per month
12-12
Reasons for In-Kind Transfers

Commodity Egalitarianism

Reduce Welfare Fraud


Lying for Cash
Political Factors

Help Specific Industries
12-13
Simple Utilitarianism

Utilitarian Social Welfare Function:
W = F(U1, U2, ,,,, Un)

“Promote Greatest Good for Greatest Number”

Additive Social Welfare Function
W = U1 + U2 + … + Un

Assume

Individuals have identical utility functions that depend only on
their incomes

Utility functions exhibit diminishing marginal utility of income

Total amount of income is fixed
12-14
Peter’s marginal utility
Paul’s marginal utility
Implications for Income Inequality
e
f
d
c
MUPeter
0
Paul’s income
MUPaul
a
b
I*
0’
Peter’s income
12-15
Peter’s marginal utility
Paul’s marginal utility
Implications for Income Inequality
e
f
d
c
MUPeter
0
Paul’s income
MUPaul
a
b
I*
0’
Peter’s income
12-16
Peter’s marginal utility
Paul’s marginal utility
Implications for Income Inequality
e
f
d
c
MUPeter
0
Paul’s income
MUPaul
a
b
I*
0’
Peter’s income
12-17
Peter’s marginal utility
Paul’s marginal utility
Implications for Income Inequality
e
f
d
c
MUPeter
0
Paul’s income
MUPaul
a
b
I*
0’
Peter’s income
12-18
Further Evaluation

Perfect Equality is Best

Examine Assumptions
12-19
Further Evaluation

Examine Assumptions

Individuals have identical utility functions that
depend only on their incomes

Your Utility?

My Utility vs. Your Utility?

Ethics
12-20
Further Evaluation

Examine Assumptions

Utility functions exhibit diminishing marginal
utility of income

True for Goods

True for Income?
12-21
Further Evaluation

Examine Assumptions

Total amount of income is fixed

Redistribution Distorts
12-22
The Maximin Criterion

John Rawls Social Welfare Function
W = Minimum(U1, U2, …, Un)

Original position


“behind the veil of ignorance”
Maximin Criterion

No inequality acceptable unless it works to the
advantage of the least well off.
12-23
The Maximin Criterion

Critique

Original Position

Risk Adverse?

Strange Outcomes

Help Poor

Benefit Rich

Hurt Everybody In Between
12-24
Pareto Efficient Income Redistribution

Pareto Efficient Redistribution



Utility Function


a reallocation of income that increases (or does
not decrease) the utility of all consumers.
Possible?
Ui = F(X1, X2, …, Xn, U1, U2, …, Ui-1, Ui+1, …, Um)
Charity > Reduced Consumption
12-25
Pareto Efficient Income Redistribution




Government Reduces Cost of Redistribution
Income Distribution as a Public Good
Social Safety Net
Social Stability
12-26
Other Considerations

Processes versus Outcomes

Process Fair?

Outcome Fair

Mobility

Corruption
12-27