Income Inequality, Poverty, and Discrimination
CHAPTER TWENTY
INCOME INEQUALITY, POVERTY, AND DISCRIMINATION
CHAPTER OVERVIEW
The statistical information, analytical concepts, and discussions of public policy alternatives can help
students find their way through the maze of controversial topics and issues concerning income
distribution and poverty.
The chapter begins by surveying some basic facts concerning the distribution of income in the United
States and the Lorenz Curve that gives a graphic representation of the distribution. Next, the major
causes of income inequality are considered, as well as historical trend information. Third, the debate
over income inequality and the tradeoff between equality and efficiency implied by this debate is
examined. Fourth, the poverty problem in America is analyzed. Finally, discrimination is analyzed.
I.
Income inequality facts
A. In 2006, almost 36.5 million Americans—12.3 percent of the population—lived in poverty,
500,000 were estimated to be homeless, the richest fifth of American households received
about 50.5 percent of total income, the poorest fifth 3.4 percent.
B. The distribution of Household Income for 2006 is shown in Table 20.1 and Figure 20.1.
1. Average family income in 2006 was $66,570.
2. Over 25.2 percent of the households had annual incomes of less than $25,000, 19.1
percent had annual incomes of $100,000 or more.
3. The top 20 percent of the households received half (50.5 percent) of all income, more
than ten times as much as the lowest 20 percent of households.
C. The Lorenz curve depicts income distribution graphically. Figure 20.1.
1. If income were distributed perfectly equally, the Lorenz curve would be the straight-line
diagonal line.
2. The extent to which the actual income distribution varies from the line of perfect
equality is the measure of inequality; the greater the distance of the curve from the line
of equality, the more unequal the distribution of income.
3. The extreme would be a line that follows the horizontal axis to the right until it meets the
right vertical axis and then turns upward along that axis.
4. The Lorenz curve can be used to compare changes in the curve over time or to compare
income distributions across countries.
D. The Gini ratio measures the distribution numerically.
1. The Gini ratio is measured as the ratio of the area between the Lorenz curve and diagonal
to the total area below the diagonal.
2. Higher numbers signify greater income inequality; lower numbers imply a more equal
distribution. The Gini ratio is bounded between zero and one.
3. The Gini ratio for the U.S. in 2006 was 0.47, but it was higher for African-Americans
(0.486) and lower for Hispanics (0.448), Asians (0.476), and whites (0.462).
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4. Wealthier, more industrialized nations tend to have lower Gini ratios, while poorer, less
developed nations have higher ratios.
E. Income Mobility: The Time Dimension
1. The income accounting period of a year is too short to be meaningful in judging income
inequality. Over a period of time—several years, a decade, or a lifetime—earnings
might be more equal.
2. If Brad earns $1,000 in year 1 and $100,000 in year 2, while Jenny earns $100,000 in
year 1 and $1000 in year 2, income distribution looks unequal in a single year, but
appears equal over the two-year period.
3. There is considerable “churning around” in the distribution of income over time.
Movement between quintiles is called income mobility.
4. Most income receivers start at a low level, peak during middle age, and then decline. As
a result, considerable income inequality will exist in any specific year because of age
differences.
5. Individuals and households will move up to higher quintile groups or move down to
lower quintile groups. This is called income mobility.
F. Effect of Government on Redistribution
1. The income date in Table 20.1 and Figure 20.1 show before-tax, cash income, including
earnings (wages, salaries, dividends, interest) and cash transfers (social security,
unemployment compensation, welfare payments).
2. The figures do not take into account outlays for personal income taxes and payroll
(social security) taxes. Nor do they include in-kind (noncash) transfers such as
Medicare, Medicaid, food stamps or housing subsidies.
3. Government significantly redistributes income from higher to lower income households
through taxes and transfers. (Figure 20.2)
a. Without government redistribution, the lowest 20 percent of households would have
received only 1.5 percent of total income. With redistribution they receive 4.4
percent.
b. Because the American tax system is only modestly progressive, transfer payments
are the most important method of redistribution. They account for more than 75
percent of the income of the lowest quintile.
II.
Income Inequality: Causes
A. Ability differences lead to differences in earnings.
B. Education and training correlate closely with differences in earnings. In general, the more
education, the higher the income.
C. Discrimination in education, hiring, training, and promotions contributes to income
inequality.
1. If women and minorities are restricted to certain occupations, there will be an oversupply
of workers relative to demand and wages and incomes will be low.
2. If women and minorities are restricted from entering white-male occupations, there will
be an undersupply of workers relative to demand and wages and incomes will be high.
D. Differences in tastes and risk preferences lead to different incomes.
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1. Workers who are willing to work long hours at arduous jobs will tend to earn more.
2. Those who are willing to assume risk, e.g., entrepreneurs, are likely to earn more income.
E. Unequal distribution of wealth:
1. Wealth is a “stock,” reflecting at a particular moment the financial and real assets an
individual has accumulated over time. A retired person may have little income but vast
amounts of accumulated wealth.
2. Ownership of wealth in the United States is more unequal than the distribution of
income. (See Last Word)
3. This inequality of wealth leads to inequality in rent, interest and dividends, which
contributes to income inequality.
F. Market power in the product market can lead to a firm receiving monopoly profits. A union
or professional organization may be able to restrict the supply of labor, thus leading to higher
than competitive wages and incomes.
G. Luck, connections, and misfortune are other forces explaining income differences. (Key
Question 5)
H. Inequality is not unique to the United States. Global Perspective 20.1 compares income
inequality across several nations.
III.
Trends in inequality
A. Absolute incomes have risen over time, while the relative distribution by quintile has been
changing.
B. Table 20.2 examines the relative income distribution by quintiles for selected years: 1970,
1975, 1980, 1985, 1990, 1995, 2000, and 2006. Income inequality has steadily increased
since 1970, as revealed by the following data:
1. Shares for the bottom 80 percent have declined, including the share going to the lowest
20 percent eroding from 4.1 percent to 3.4 percent of household income.
2. The income share going to the top 20 percent has risen from 43.4 percent to 50.5 percent,
from 16.6 percent to 22.3 percent for the top 5 percent of households.
C. Causes of growing inequality.
1. Firms have increased their demand for highly skilled and well-educated workers.
Because the demand for these workers continues to exceed the supply, wages have been
bid up. Between 1980 and 2003, the wage difference between college graduates and
high school graduates increased. The growth of income to business, athletic, and
entertainment “superstars” has increased income inequality.
2. In terms of demographics, large numbers of less-experienced and less-skilled “baby
boomers” entered the labor force during the 1970s and 1980s, thus contributing to
greater inequality during those decades. When high earnings potential men and women
marry, the income to the highest quintile will likely increase. An increase in the number
of households headed by single women has lead to greater inequality.
3. More international competition has reduced the demand for less-skilled, high-paid and
often union workers in manufacturing industries in the U.S. There has been an upsurge
in immigration of unskilled workers.
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4. Two cautions: First, all quintiles have grown in terms of absolute income, but growth
was fastest in the top quintile. Second, increased income inequality is not unique to the
U.S. (Global Perspective 20.1)
D. CONSIDER THIS … Laughing at Shrek compares income to consumption inequality
IV.
Equality vs. Efficiency
A. The case for equality is based on the idea that more equal distribution will maximize utility.
If income is subject to diminishing marginal utility, then people at the high end of the income
scale receive less utility per dollar of income than people at the low end. The argument is
that utility would be raised if low-income people were given more by taking it from the
high-income groups. The high-income earners would lose less utility than the low-income
groups would gain. This idea is illustrated in Figure 20.3, which assumes that money
incomes are subject to diminishing marginal utility (Chapter 7). If this is true, utility would
be maximized when each has the same amount of income dollars.
B. The case for inequality is that inequality is an important determinant of the amount of
income produced and available for distribution overall. In other words, inequality provides
an incentive for people to work harder and more efficiently.
C. CONSIDER THIS … Slicing the Pizza
If everyone receives a slice of a size relative to his or her contribution, the total pizza is
larger. If everyone receives the same size slice regardless of contribution, some will lose the
incentive to work and the pizza will shrink. Society must decide how much smaller of a
pizza it is willing to tolerate in order for everyone to have an adequate slice.
V.
The Economics of Poverty
A. The degree of income inequality will not predict the amount of poverty in a society.
B. Poverty is defined as a situation in which a family’s basic needs are greater than its means of
satisfying them. The poverty-level income is defined officially by government agencies
based on family size. In 2006 poverty-level income was $9800 for a single person; $20,000
for a family of four; and $26,800 for a family of six. About 36.5 million people or 12.3
percent of the population lived in poverty in 2004 according to this definition. Note that
while the figures include cash transfers, they do not include in-kind transfers like medical
care, housing assistance, and food stamps.
C. The poor are not homogeneous, nor are they randomly distributed. Figures 20.4 and 20.5
provide details about the incidence of poverty among different groups in our society.
1. African-Americans and Hispanics bear a disproportionate share of poverty compared to
whites (24.3, 20.6, and 10.3 percent, respectively, in 2006).
2. The incidence of poverty is extremely high (30.1) among female-headed households,
foreign-born people who are not citizens (19.5), and children under 18 years of age
(17.8).
3. Although there has been considerable movement out of poverty, poverty is much more
long-lasting among African-American and Hispanic households, households headed by
women, persons with little education and few labor market skills, and people who are
personally and socially dysfunctional.
D. Poverty Trends
1. Figure 20.5 shows that total poverty fell between 1959 and 1969, stabilizing at 11 to 13
percent over the 1970s, and then rose in the early 1980s.
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2. Between 1993 and 2000, the poverty rate fell from 15.1 to 11.3 percent.
3. The recession in 2001, and subsequent slow employment and wage growth increased the
rate to 11.7 percent in 2001, and to 12.3 percent in 2006.
E. Measurement Issues – Poverty rates must be interpreted carefully.
1. Official definitions and income thresholds are arbitrary and may not accurately measure
the poverty being experienced.
2. Those just above the official poverty line but living in big (and expensive) cities often
struggle to meet basic needs, despite not being poor by government standards.
3. Poverty statistics are based on income, not actual consumption, and do not include
withdrawals from saving, borrowing, selling assets, or in-kind (noncash) transfers. Some
people may be living better than their official poverty status suggests.
VI.
The Income Maintenance System (Table 20.3)
A. The reduction in poverty is a widely accepted goal of public policy. Despite recent attempts
to slow the upward trend in spending on these programs, enormous amounts of money are
being spent.
B. The U.S. income-maintenance system consists to two kinds of programs: social insurance
and public assistance. Both types are also known as entitlement programs.
C. Social insurance programs are viewed as earned rights because the beneficiaries have paid
into them. Social Security, unemployment compensation, and Medicare fit this category.
1. Social Security, the Federal pension program, is financed by a payroll tax of 6.2 percent
levied on both the worker and the worker’s employer on the first $102,000 of wage
income. Currently, over 90 percent of the labor force is covered by this system.
Roughly 50 million people received OASDHI benefits averaging about $1082 per month.
2. Medicare (part of Social Security) is a Federal health insurance program for the elderly
and disabled. It is financed by a 1.45 percent payroll tax levied on both the worker and
the worker’s employer (with no income limit). It also includes a low-cost voluntary
supplemental insurance, which helps pay for doctor fees and prescription drugs.
3. Unemployment compensation is sponsored in all fifty states in cooperation with the
Federal government. The size of payments and the number of weeks of coverage vary
from state to state. Benefits averaged about $262 per week in 2005.
D. Public assistance programs provide benefits for those who are unable to earn income because
of permanent handicaps or having no or very low incomes and also having dependent
children. The Federal government finances about two-thirds of the welfare program
expenditures, the rest being paid by the states.
1. Supplemental Security Income (SSI) is a program for people who are unable to work
because of disability and who do not qualify for other programs. In 2007 it paid an
average of $603/month for individuals and $904/month for couples if both were eligible.
2. Temporary Assistance for Needy Families (TANF) is state-administered but partly
financed with federal grants. It provides aid to families with children and also seeks to
reduce welfare dependency by providing job preparation and work. In 2007 about 3.9
million people received TANF assistance.
3. The food stamp program is for low-income Americans who may qualify for coupons that
are redeemable for food. The number of coupons received depends on a family’s size
and income, intended to provide a “nutritionally adequate diet.”
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4. Medicaid helps finance medical expenses of individuals in SSI and TANF programs.
5. The Earned Income Tax Credit (EITC) is a refundable tax credit for low-income working
families with children, which reduces income taxes owed or provides the families with a
cash payment if the credit exceeds their tax liability. The purpose of the credit is to
offset social security taxes paid by low-wage earners. EITC is a wage subsidy that can
pay as much as $2 per hour for the lowest-paid workers with families. Twenty-two
million recipients qualified for the program in 2003 and the total cost was $41 billion.
6. There are a number of other programs available to assist the needy, including housing,
energy, educational, and Veteran’s assistance.
VII.
Discrimination
A. Economic discrimination occurs when female or minority workers, who have the same
abilities, education, training, and experience as white male workers, are accorded inferior
treatment with respect to hiring, occupational access, promotion, or wage rate.
B. Types of discrimination.
1. Wage discrimination occurs when minority workers or women are paid less than white
males for doing the same work. This practice violates Federal law, but it can be subtle
and difficult to detect.
2. Employment discrimination takes place when women or minority workers receive
inferior treatment in hiring, promotions, layoffs, or permanent discharges. This type of
discrimination also includes sexual and racial harassment.
3. Occupational discrimination occurs when women or minority workers are arbitrarily
restricted or prohibited from entering the more desirable, high-paying occupations.
Historically, craft unions have effectively barred African-Americans from membership
and, thus, from employment.
4. Human capital discrimination occurs when investments in education and training are less
and inferior to that of whites.
VIII.
Economic Analysis of Discrimination
A. Taste-for-discrimination model. (Figure 20.6)
1. The model assumes that, for whatever reason, prejudiced employers experience a
subjective and psychic cost—a disutility—whenever they must interact with those they
are biased against.
B. Prejudice and the market African-American-white wage ratio.
1. For a particular supply of African-American workers, the actual African-American-white
wage ratio will depend on the collective prejudice of white employers. (See Figure 20.6)
2. An increase in white employer prejudice, i.e., a decrease in the demand for AfricanAmerican workers, reduces the African-American wage rate and thus the AfricanAmerican-white wage ratio.
3. A decrease in white employer prejudice, i.e., an increase in the demand for AfricanAmerican workers, increases the African-American wage rate and thus the AfricanAmerican-white wage ratio.
C. Statistical discrimination
1. People are judged on the basis of the average characteristics of the group to which they
belong, rather than on their own personal characteristics or productivity.
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2. The firm practicing statistical discrimination is not being malicious in its hiring behavior
(although it may be violating antidiscrimination laws). The decision it makes will be
rational and, on average, profitable.
a. In hiring, an employer wants to find the best person for the job, but collecting all of
the information on each possible candidate can be expensive.
b. Employers may reduce the cost of hiring by using the average characteristics of
women and minorities in determining whom to hire; the employer is using crude
indicators of gender, race, or ethnic background as a measure of production-related
attributes.
c. By reducing hiring costs, the use of statistical discrimination may increase the
employer’s profits.
D. Occupational segregation can cause crowding or an oversupply of workers in the few
occupations that are left to the class of workers experiencing discrimination. This theory
helps to explain the relatively low wages of women relative to men. (Figure 20.7 explains
this in supply and demand diagrams.)
1. The crowding model illustrated in Figure 20.7 includes the following assumptions: the
number of male and female (or African-American and white) workers is equal; the
economy has three occupations; the two groups of workers have identical labor force
characteristics—anyone could fill a position equally well.
2. There are several effects of crowding.
a. Wages will be lower in the few occupations where women are not discriminated
against because most women are “crowded” into these occupations. The supply is
unnaturally large relative to demand.
IX.
b. Eliminating discrimination will shift women from the low-wage occupations into
higher-wage occupations, bringing about an equilibrium wage that should be the
same in all occupations requiring similar types of workers without respect to gender.
3. The conclusion is that society will gain from a more efficient allocation of resources
when discrimination is abandoned. (Key Question 9)
LAST WORD: Some Facts on U.S. Family Wealth and Its Distribution
A. In 2006, the Federal Reserve reported that household wealth (net worth) in the U.S. increased
between 1995 and 2004, but that its distribution became more unequal.
B. Median income and average income, adjusted for inflation, was considerably higher in 2004
than in 1995.
C. In 2004, the wealthiest 10 percent of the households owned 69.5 percent of the total wealth
and the wealthiest 1 percent owned 33.4 percent; this compares with 67.8 percent and 34.6
percent, respectively, in 1995.
D. The bottom 90 percent of the households owned 32.2 percent of the wealth in 1995 and 30.5
percent in 2004.
E. Good news/bad news: While median and average wealth rose substantially, the bottom 90
percent of the households experienced less rapid increases in wealth.
F. There are various public policy questions that arise from this latest wealth information,
including whether the estate tax should be eliminated.
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ANSWERS TO END-OF-CHAPTER QUESTIONS
20-1
Using quintiles to briefly summarize the degree of income inequality in the United States. How
and to what extent does government contribute to income equality?
The income share received by the highest 20 percent was 50.5 percent in 2006, which is more
than ten times the 3.4 percent received by the lowest 20 percent. The middle three quintiles
receive under 50 percent of the total before-tax income. The top two quintiles receive twice as
much as the bottom three quintiles combined; in fact, the top 20 percent receives more than the
bottom 80 percent.
The effect of government on the distribution of income occurs through both taxes and transfer
payments. The total effect of federal, state, and local taxes on income distribution is mildly
progressive in that high-income households pay a somewhat higher proportion of their incomes
in taxes than low-income families. But about 80 percent of government’s contribution to income
equality takes place through transfer programs. This contribution is particularly significant for
those in the lowest quintile, for whom government transfer payments comprise over 75 percent of
total income.
These statistics do not necessarily mean that the contribution of government in furthering
equality is entirely positive. To the extent that transfer programs aimed at lower-income
households decrease the incentive to work, the earned incomes of these households will be less
than otherwise. Also, some transfer programs go to the non-poor. For example, most farm
subsidies go to the wealthiest farmers, and higher education funding tends to benefit middle to
high-income students.
20-2
(Key Question) Assume Al, Beth, Carol, David, and Ed receive incomes of $500, $250, $125,
$75, and $50 respectively. Construct and interpret a Lorenz curve for this five-person economy.
What percentage of total income is received by the richest and by the poorest quintiles?
See the figure below. In this simple economy each person represents a complete income
quintile—20 percent of the total population. The richest quintile (Al) receives 50 percent of total
income; the poorest quintile (Ed) receives 5 percent.
20-3
How does the Gini ratio relate to the Lorenz curve? Why can’t the Gini ratio exceed 1? What is
implied about the direction of income inequality if the Gini ratio declines from 0.42 to 0.35?
How would one show that change of inequality in the Lorenz diagram?
The Gini ratio is the numerical measurement of the inequality depicted by the Lorenz curve. It is
calculated by dividing the area between the curve and the diagonal by the total area below the
diagonal.
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The Gini ratio can’t exceed 1 because if the Lorenz curve is as far as possible from the diagonal
(line of equality), the area between the curve and the diagonal will equal the total area below the
diagonal. The equality will result in a Gini ratio of 1.
A decline in the Gini ratio implies less income inequality; and it would be graphically depicted
by moving the Lorenz curve closer to the diagonal.
20-4
Why is the lifetime distribution of income more equal than the distribution in any specific year?
The disparity of incomes in a single year reflects the income distribution at a point in time. The
very young and very old will receive lower incomes, while the middle-aged tend to receive
higher incomes, giving a picture of great inequality. However, if we view these same groups
over time, there is considerable income mobility both up and down the income quintile groups,
suggesting that income is more equally distributed over a five-, ten-, or twenty-year period for
these same households.
20-5
(Key Question) Briefly discuss the major causes of income inequality. With respect to income
inequality, is there any difference between inheriting property and inheriting a high IQ? Explain.
The reasons for income inequality are: differences in abilities and talents among individuals,
differences in the amount of education and training an individual obtains, labor market
discrimination, differences in tastes and preferences toward work and job attributes, inequality in
the distribution of wealth, the ability to use market power to transfer income to oneself, luck,
connections, and misfortune.
A high IQ normally does not lead to high income unless it is combined with personal initiative
and favorable social circumstances. Inherited property—as long as it is competently managed—
provides income irrespective of one’s character and personal attributes. Both factors are largely
a matter of the luck of being born into a family with good ability genes and/or wealth (Warren
Buffett’s “lucky sperm club”). What one does with the genes or wealth is up to the recipient.
20-6
What factors have contributed to increased income inequality since 1970?
Several factors have contributed to the increase in income inequality since 1970. The overriding
factor is the structural changes that have occurred in the U.S. economy. There has been an
increase in the demand for high-skill and well-educated workers relative to lesser-skilled
workers. During the 1970s and 1980s less experienced, younger people entered the labor force
in large numbers, thus reducing their incomes. There also was a rise in the number of single
mothers with children, but few labor market skills. More recently, there has been a tendency for
well-educated men and women to marry, thus placing these families in the highest quintile and
increasing the income to those in that quintile. Increased divorce rates have tended to push
female-headed households into poverty. Other structure changes include more import
competition resulting in a reduction in the demand for and employment of less-skilled workers
who used to command high-paying, often union, jobs in manufacturing and an increased the
immigration of unskilled workers.
20-7
Should a nation’s income be distributed to its members according to their contributions to the
production of that total income or to members’ needs? Should society attempt to equalize
income or economic opportunities? Are the issues of equity and equality in the distribution of
income synonymous? To what degree, if any, is income inequality equitable?
The answer to this question is inextricably tied to value judgments, but most of us probably favor
a combination of the two types of income distribution. A purely capitalist system, in which
incomes are determined exclusively by the market mechanism, would mean that those who, for
whatever reason, are unable to contribute to production would have to depend exclusively on
private charity for their livelihood. A (hypothetical) communist state also leads to a seemingly
intractable problem—if income is to be distributed purely on the basis of need, why would
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anyone engage in production? Most modern societies attempt to seek a compromise of one sort
or another between these two extremes. The compromise that is actually found often differs
markedly from what prevailing political rhetoric in that society might suggest. Socialist
economies, which historically have had large differences in income distribution, also have
wider-ranging government transfer programs than most capitalist economies.
Conservatives contend that because of the tradeoff between equality and efficiency, society
should content itself with attempting to ensure equality of opportunity. Liberals argue that
income redistribution is essential since equality of economic opportunity is impossible in an
economy with wide differences in income, especially when these differences are related to the
inheritance of property.
Income equity refers to how fairly income is distributed. One can argue that some inequality of
income is not only necessary for reasons of efficiency but is fairer than an equal distribution of
income, since those who produce more deserve to be rewarded for their efforts. But unequal
incomes are not necessarily related to differences in individual ability or effort. It is difficult to
defend the inequalities that result from market power and discrimination as being equitable. The
justness of inherited wealth is also questionable. Liberals argue that by creating inequality of
opportunity, property inheritance is inherently unjust. Conservatives contend that allowing
individuals to pass on wealth to whom they wish is much fairer than having wealth appropriated
by the government.
20-8
Do you agree? Or disagree? Explain your reasoning. “There need be no tradeoff between
equality and efficiency. An ‘efficient’ economy that yields an income distribution that many
regard as unfair may cause those with meager income rewards to become discouraged and stop
trying. So efficiency may be undermined. A fairer distribution of rewards may generate a higher
average productive effort on the part of the population, thereby enhancing efficiency. If people
think they are playing a fair economic game and this belief causes them to try harder, an
economy with an equitable income distribution may be efficient as well.”
While there is certainly an “efficiency wages” aspect to a more equal distribution, it is hard to
imagine that the disincentive effects on both high- and low-income earners of income
redistribution will be swamped by an increased interest on the part of some of the poor in
“playing the economic game.” Without the prospect of higher incomes, few individuals in an
economy—including the poor—would choose to increase their productivity. What would
increase individual effort and hence aggregate efficiency is the perception that opportunities for
all are equal in every respect. In other words, it is not so much an unequal distribution of income
that causes some members of society to become discouraged and stop participating in the market,
but rather the wide-ranging perception that the deck is stacked against them. Many feel they can
never earn incomes commensurate with their abilities and efforts because of a lack of financial
resources, restricted access to education, or barriers in the workplace.
20-9
Comment on or explain:
a. Endowing everyone with equal income will make for very unequal enjoyment and
satisfaction.
b. Equality is a “superior good”; the richer we become, the more of it we can afford.
c. The mob goes in search of bread, and the means it employs is generally to wreck the
bakeries.
d. Some freedoms may be more important in the long run than freedom from want on the part of
every individual.
e. Capitalism and democracy are really a most improbable mixture. Maybe that is why they
need each other—to put some rationality into equality and some humanity into efficiency.
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f.
The incentives created by the attempt to bring about a more equal distribution of income are
in conflict with the incentives needed to generate increased income.
(a) No distribution of income can ensure equal enjoyment. Using marginal utility theory, it can
be argued that by equalizing incomes in an economy, there is the probability of maximizing
total utility for all individuals. This assumes that everyone has identical diminishingmarginal-utility-of-money schedules.
(b) The lessening of poverty provides a host of indirect benefits to affluent members of
society—social peace, physical security, and perhaps the intangible satisfaction of living in a
more equitable society. The better off the affluent become, the more they are willing to
spend in order to purchase these benefits.
(c) Mobs commonly exhibit a marked preference for present over future consumption. Many
conservatives contend that the income redistribution schemes resulting from democratic
decision making suffer from a similar failing by decreasing the incentive to accumulate
capital in order to provide present consumption to the poor. Is this view valid? Perhaps.
Does this mean that such redistribution schemes are misguided? Not necessarily.
(d) This is a common conservative view, that civil and political liberties are more important than
the universal eradication of poverty. Liberals are likely to contend that ensuring universal
freedom from want does not necessarily detract from these fundamental freedoms.
(e) The principles underlying the two systems can be summarized as follows: Each dollar has a
vote in the marketplace, and each person has a vote at the ballot box. These principles are
similar enough that the presence of one often leads to the other. They are dissimilar enough
so that the type of society that arises from a combination of the two represents a workable
social compromise.
(f) Incentives created in the attempt to bring about more equal distribution of income may cause
a tradeoff in decreased economic efficiency. Higher marginal taxes may reduce the efforts of
those at the top to work harder and produce more. Greater benefits to those at the bottom
may reduce their incentive to do the same as they receive benefits without the productive
effort. In so far as this tradeoff occurs, there will be a reduction in economic growth and
therefore, damage to incentives leading to increased incomes.
20-10 (Key Question) How do government statisticians determine the poverty rate? How could the
poverty rate fall while the number of people in poverty rises? Which group in each of the
following pairs has the highest poverty rate: (a) children or people age 65 or over? (b) AfricanAmericans or foreign-born noncitizens? (c) Asians or Hispanics?
Government statisticians determine who is officially in poverty by comparing family incomes to
a threshold based on family size. The threshold is intended to represent the minimum income
needed for that family size to satisfy basic needs for food, clothing, shelter, and transportation.
The poverty rate can fall, despite the number in poverty rising, if the population grows faster
than the number of people in poverty.
(a) Children have a higher poverty rate (17.8) than persons 65 or over (9.8).
(b) African-Americans have a higher poverty rate (24.7) than foreign-born noncitizens (21.0).
(c) Hispanics have a higher rate (21.9) than Asians (9.8).
20-11 What are the essential differences between social insurance and public assistance programs?
Why is Medicare a social insurance program, whereas Medicaid is a public assistance program?
Why is the earned-income tax credit considered to be a public assistance program?
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Income Inequality, Poverty, and Discrimination
Social insurance programs provide aid to those who are retired or suffering from temporary
distress. They are usually financed through payroll levies and are viewed to be earned rights
because they are paid for by recipients. Public assistance programs provide benefits for those
who are unable to earn income because of permanent handicaps or who have no or very low
income and have dependent children. To receive assistance, an individual must pass a “means”
test. The cash payments are paid for out of general tax revenues. Most of these revenues come
from individuals other than the recipients.
The Medicare program is a part of the Social Security program and is financed with a 2.9 percent
tax on wage and salary earnings. Those who have reached 65 years of age are eligible to
participate in the program. Medicaid is a program for individuals who are participating in the
SSI and TANF programs. It is financed from general tax revenues and is available only to
qualified individuals.
The earned-income tax credit is considered a public assistance program because it is targeted at
low-income families.
20-12 (Key Question) The labor demand and supply data in the following table relate to a single
occupation. Use them to answer the questions that follow. Base your answers on the taste-fordiscrimination model.
Quantity of
Hispanic labor
demanded,
thousands
Hispanic
wage
Rate
Quantity of
Hispanic labor
supplied,
thousands
24
30
35
42
48
$16
14
12
10
8
52
44
35
28
20
a. Plot the labor demand and supply curves for Hispanic workers in this occupation.
b. What are the equilibrium Hispanic wage rate and quantity of Hispanic employment?
c. Suppose the white wage rate in this occupation is $16. What is the Hispanic-to-white wage
ratio?
d. Suppose a particular employer has a discrimination coefficient d of $5 per hour. Will that
employer hire Hispanic or white workers at the Hispanic-white wage ratio indicated by part
c? Explain.
e. Suppose employers as a group become less prejudiced against Hispanics and demand 14
more units of Hispanic labor at each Hispanic wage rate in the table. What are the new
equilibrium Hispanic wage rate and level of Hispanic employment? Does the Hispanic-white
wage ratio rise or fall? Explain.
f.
Suppose Hispanics, as a group, increase their labor services in this occupation, collectively
offering 14 more units of labor at each Hispanic wage rate. Disregarding the changes
indicated in part e, what are the new equilibrium Hispanic wage rate and level of Hispanic
employment? Does the Hispanic-white wage ratio rise, or does it fall?
(a)
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Income Inequality, Poverty, and Discrimination
S
Wage
$12
D
35
Quantity of Hispanic Workers
(thousands)
(b) The equilibrium Hispanic wage rate is $12; the equilibrium quantity of Hispanic employment
is 35,000 workers.
(c) The Hispanic-to-white wage ratio is .75 (= $12/$16).
(d) The employer will hire only white workers because the $5 discrimination coefficient exceeds
the $4 difference between the wage rates of whites and Hispanics.
(e) The new equilibrium Hispanic wage rate is $14 and the new equilibrium quantity of Hispanic
employment is 44,000 workers. The Hispanic-white wage ratio rises to .875 (= $16/$14)
because of the increased demand for Hispanic labor in relation to the unchanging supply of
Hispanic labor.
(f) The new equilibrium Hispanic wage rate is $10 and the new equilibrium quantity of Hispanic
employment is 42,000. This Hispanic-white wage ratio falls to .625 (= $10/$16).
20-13 Males under the age of 25 must pay far higher auto insurance premiums than females in this age
group. How does this fact relate to statistical discrimination? Statistical discrimination implies
that discrimination can persist indefinitely, while the taste-for-discrimination model suggests that
competition might reduce discrimination in the long run. Explain the difference.
Statistical discrimination occurs when people are judged on the basis of the average
characteristics of the group to which they belong. Insurance companies base auto insurance
premiums on the statistical information available, and the consequent discrimination will
continue as long as there is a difference in accident rates by gender in this age group.
The taste-for-discrimination model suggests that competition will reduce discrimination in the
long run. Firms that do not discriminate will have lower actual wage costs per unit of output and
lower average total costs than will the firms that discriminate. These lower costs will allow
nondiscriminating firms to charge lower prices. This should eventually drive the discriminating
firms out of the market.
20-14 (Key Question) Use a demand and supply model to explain the impact of occupational
segregation or “crowding” on the relative wage rates and earnings of men and women. Who
gains and who loses from the elimination of occupational segregation? Is there a net gain or net
loss to society? Explain.
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Income Inequality, Poverty, and Discrimination
See Figure 20.7. Discrimination against women in two of the three occupations will crowd
women into the third occupation. Labor supply in the “men’s occupations” (X and Y) decreases,
making them high-wage occupations. Labor supply in the “women’s occupation” (Z) increases
creating a low-wage occupation.
Eliminating occupational segregation would entice women into the high-wage occupations,
increasing labor supply there and reducing it in the low-wage occupation. The wage rates in the
three occupations would converge to B. Women would gain, men would lose. Society would
gain because the increase in output in the expanding occupations would exceed the loss of output
in the contracting occupation.
20-15 (Last Word) Go to Table 1 in the Last Word and compute the ratio of average wealth to median
wealth for each of the 4 years. What trend do you find? What is your explanation for the trend?
The Federal estate tax redistributes wealth in two ways: by encouraging charitable giving, which
reduces the taxable estate, and by heavily taxing extraordinarily large estates and using the
proceeds to fund government programs. Do you favor repealing the estate tax? Explain.
The average wealth was 3.7 times greater than median wealth in 1995, 3.94 times greater in 1998,
4.6 times greater in 2001, and 4.8 times greater in 2004. Since 1995, the wealthiest 10 percent
have experienced a disproportionate increase in their wealth when compared to the other 90
percent. Greater income inequality, stock market gains (at least through 2000), and tax cuts
explain some of the (relative and absolute) gains in wealth at the top.
Just as public assistance programs can have a disincentive on work, inheritance, or even the hope
for inheritance, can have a negative incentive effect on the likely recipients. On the other hand,
those who have worked hard and saved believe that they should be able to pass this wealth on to
their heirs. Rather than repealing the tax, changes in the tax might be preferable. Such reform
might include increasing the amount of wealth that can to inherited before the estate tax is
applied.
312