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