Principles of Economics
2nd edition
by Fred M Gottheil
Chapter 18 Income Distribution & Poverty
PowerPoint Slides prepared by Ken Long
©1999 South-Western College Publishing
1
What are the different
ways of making income?
• Wages
• Interest
• Rent
• Profit
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What makes rich
people rich?
Interest, rent, and profit
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What are some techniques
used to measure income
distribution?
Quintiles
The Lorenz Curve
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The Distribution of Money Income
of U.S. Families by Quintiles
HH
Bottom 5th
Second 5th
Third 5th
Fourth 5th
Top 5th
Top 5%
1929
3.9
8.6
13.8
23.1
54.5
1947
5.0
11.8
17.0
23.1
43.0
17.2
15.9
1980
4.3
10.3
16.9
24.9
43.7
15.8
1990
3.9
9.6
15.9
24.0
46.7
18.6
(Percentages)
1995
3.7
9.1
15.2
23.3
48.7
21.0
Changes in the income
distribution
Distribution got somewhat
more equal during the
depression, stayed pretty
much the same from the 40’s
to the 80’s, and has gotten
more unequal since then
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What is the
Lorenz Curve?
Shows the percentage of total
income received by a given
percentage of recipients
whose incomes are arranged
from smallest to largest
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The Lorenz Curve
Cumulative
% of Income
100
Line of
Perfect
Equality
0
100
Cumulative % of families
8
Cumulative Percent of Income
Lorenz Curve
Cumulative % of families
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9
The Bureau of the
Census provides income
& poverty information
http://www.census.gov
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What is the
Gini Coefficient?
A numerical measure of
the degree on income
inequality in an economy
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What does the Gini
Coefficient have to do
with the Lorenze Curve?
The coefficient transforms
the Lorenze Curve into a
numerical value
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Cumulative Percent of Income
Areas produced by the
Lorenze Curve
G = A/(A+ B)
A
B
Cumulative % of families
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With the Gini Coefficient,
what do the #’s mean?
A number of 0 is perfect
income equality
A number of 1 is perfect
income inequality
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Gini Coefficients, US
1970
1975
1980
1985
1990
1995
.394
.397
.403
.419
.428
.450
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How unequal is the income
distribution in the U.S.?
It is more uneven than in
some countries and less
uneven than others
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16
What is Wealth?
The accumulated assets
owned by individuals
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What is
Life Cycle Wealth?
Wealth in the form of
nonmonetary assets, such
as a house, automobiles,
and clothing
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Some problems in
measuring income
distribution
Life cycle income
Family size and effort
Underground economy
Taxes and in-kind
income
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Income Distribution at One Point
& Over Time
Year
John's
Age
John's
Income
Stephanie's
Age
Stephanie's
Income
1998
2008
2018
2028
2038
Total
18 yrs
28
38
48
58
$ 10,000
35,000
52,000
64,000
75,000
$236,000
28 yrs
38
48
58
68
$ 30,000
45,000
60,000
75,000
26,000
$236,000
Point here is that people can have the
same lifetime income yet at any
moment in time, there will be income
differences.
What are some reasons to
justify Income Equality?
• The randomness of personal
misfortune is a misfortune
• Rawls’s Theory of Justice
• There’s nothing random about
inequality
• Equality and maximum utility
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What does the “Randomness
Theory” have to say about
Income Inequality?
Good fortune is distributed
randomly so income
inequality has no justification
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What is “Rawl’s Theory
of Justice” argument?
Because income is meted
out randomly, income
equality is justified
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What is the “There’s
nothing Random about
Inequality” argument?
Because people own property
from theft, and property
determines income, incomes
should be equal
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What is the “Equality and
Maximum Utility” argument?
Because equality produces the
greatest welfare for the
greatest number of people, it
should be equalized
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For more information about
income equality:
http://www.umsl.edu/services/gov
docs/erp/1997
http://www.stack.nl/~cas/fil/philos
/rawls.html
http://www.swcollege.com/bef/eco
n_debate.html
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What are the cases for
Income Inequality?
Efficiency
Economic Growth
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What is the
“Efficiency” argument?
There has to be inequality
so that people will have an
incentive to be productive
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What is the “Economic
Growth” argument?
Because the wealthy can
afford to save, a high
savings rate makes possible
money for investments
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Factors Contributing
to Income Inequality
Innate abilities and attributes
Work and leisure preferences
Education and other training (human
capital)
Risk taking
Luck
Wage discrimination
Labor market
discrimination
Employer discrimination
Employee discrimination
Customer discrimination
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Male-female wage gap:
median salary of women about
75% that of men
Part-time work more common among women
At one time, less human capital accumulation
by women
Job choice and mobility issues
Career interruptions
Role differentiation, sexual division of labor
32
Issue of Comparable
Worth
Comparable worth--jobs that are judged
comparable in terms of skills needed,
etc, should be paid the same
Very controversial, can different jobs in
different industries be judged
comparable?
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Measuring poverty: relative or
absolute measures?
Problem with relative
measures: there will always
be a bottom 10 or 20%, or
whatever % is chosen—that
does not mean all those
people are poor
34
What is the
Poverty threshold?
The level of income below
which families are
considered to be poor
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How do we
define Poverty? Different
approaches
• As a % of median income
• Meeting basic needs
standard
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Basic needs standard of
Poverty threshold
Developed in the 1960’s based
on findings by department of
agriculture
For a family of 4, current
poverty line is around $16,000
of income
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Poverty in Different Groups, 1994
Group
% of Group in Poverty
TOTAL POPULATION
BY RACE/ETHNIC GROUP
White
African American
Hispanic
11.7
30.6
30.7
BY REGION OF COUNTRY
Northeast
Midwest
South
West
12.9
13.0
16.1
15.3
Poverty in Different Groups, 1994
Group
% of Group in Poverty
BY AGE
Under 18 years old
18-24 years old
25-34 years old
35-44 years old
45-54 years old
55-59 years old
60-64 years old
65 years old and older
21.8
18.0
13.2
10.6
7.8
10.4
11.4
11.7
BY EDUCATION
No high school diploma
High school diploma, no college
Some college, but less than bachelor’s degree
Bachelor’s degree or more
24.8
10.9
7.8
2.6
Our welfare “system”
Combination of federal and state
programs
AFDC, food stamps, public
housing, supplemental income
programs, medicaid, etc.
Criticized for high implicit tax rates
40
What is the
Negative Income Tax?
Based on a sliding scale,
below a certain income
level the government
pays money to people
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Negative income tax proposal,
alternative to current welfare
system
Let IG = Guaranteed income
t = negative income tax rate
W= cash payment under NIT
EI= family’s eared income
W = IG - t (EI)
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Example
Let IG = 5,000
t = .5 (50%)
Then if EI = 0,
W = 5,000 - .5(0) or W = 5,000
Continue in this manner for other
income levels
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• For EI = 1,000, W = 5,000 .5(1000) = 4500
• EI = 2,000, W = 5,000 - .5(2000)
= 4000
• At EI = 10,000, W = 5,000 .5(10,000) = 0
• Thus EI equals the break-even (B)
level of income, no more welfare
payment
• Note that B = IG/t
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Hypothetical Negative Income Tax
(1)
Earned
Income
(2)
Negative Income Tax
Payment (Cash Grant)
(3)
Total Income = Earned
Income + Negative
Income Tax Payment
$
$5,000
4,500
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0
$ 5,000
5,500
6,000
6,500
7,000
7,500
8,000
8,500
9,000
9,500
10,000
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
What is Median Income?
The midpoint of a society’s
income distribution
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How many people in the
U.S. live in poverty?
Poor families make up a
little more than 10% of
the population
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How does the Government
help the Poor?
Cash assistance
In-kind assistance
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• What is the Lorenze Curve?
• What is the Gini Coefficient?
• What are some reasons to justify
Income Equality?
• What are the cases for Income
Inequality?
• What is Median Income?
• How do we define Poverty?
• What is a Negative Income Tax?
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END
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