Chapter 11: Income
Inequality and Poverty
Facts about Income Inequality
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In 2003,
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the average household income in the U.S. was
$59,067.
about 17 percent of all households had annual
before-tax incomes of less than $15,000 while about
15 percent had annual incomes of more than
$100,000.
The bottom 20 percent of all households received
3.4 percent of total income; the top 20 percent
received about 50 percent of total income.
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Facts about Income Inequality
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Income inequality is the unequal
distribution of an economy’s total income
among households or families.
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One way to measure income inequality is to
look at the percentage of households in a
series of income categories.
Another way is to divide the total number of
households into five numerically equal groups,
or quintiles, and examine the percentage of
total income received by each quintile.
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The Lorenz Curve
and Gini Ratio
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A Lorenz curve is a curve that shows an
economy’s distribution of income by
measuring the cumulated percentage of
income receivers along the horizontal axis
and the cumulated percentage of income
they receive along the vertical axis.
A Gini ratio is a numerical measure of the
overall dispersion of income among an
economy’s income receivers.
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The Lorenz Curve
and Gini Ratio
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If the actual income distribution were
perfectly equal, the Lorenz curve would be
a diagonal line.
The farther the Lorenz curve sags away
from the diagonal, the greater is the
degree of income inequality.
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The Lorenz Curve
and Gini Ratio
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The Gini ratio is calculated as:
Area between Lorenz curve and diagonal
Gini ratio =
Total area below the diagonal
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As the area between the Lorenz curve and
the diagonal gets larger, the Gini ratio rises
to reflect greater inequality.
If the actual income distribution were
perfectly equal, the Gini coefficient is zero.
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Income Mobility:
The Time Dimension
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Over some period of time, income
receivers move from one part of the
income distribution to another. This is
called income mobility.
For most income receivers, income starts
out relatively low, reaches a peak during
middle age and then declines. For many,
“low income” and “ high income” are not
permanent conditions.
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Effect of Government
Redistribution
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Income data includes before-tax wages,
salaries, dividends, interest, and cash transfer
payments. It does not include taxes and
noncash transfers.
One economic function of the government is to
redistribute income.
 Most income is redistributed from the high
income earners to the low income earners.
 About 80 percent of the reduction in income
inequality is attributed to transfer payments.
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Causes of Income Inequality
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The factors that contribute to income
inequality include:
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Ability
Education and Training
Discrimination
Preferences and Risk
Unequal Distribution of Wealth
Market Power
Luck, Connections, and Misfortune
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Income Inequality over Time
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Economic growth in the U.S. has raised
incomes over a period of years.
In absolute dollar terms, the entire
distribution of income has been moving
upward, but the relative income
distribution may become more equal, less
equal or unchanged.
Since 1970, the distribution of income by
quintiles has become more unequal.
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Causes of Growing Inequality
The growing inequality in the U.S. over the
past several decades may be explained
by:
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Greater Demand for Highly Skilled Workers
Demographic Changes
International Trade, Immigration, and Decline
in Unionism
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Causes of Growing Inequality
Because of greater demand from highly
skilled and well educated workers, the
income inequality continues to grow.
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The scarcity of highly skilled workers has bid
up their wages; consequently, the wage
differentials between them and less skilled
workers have increased.
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Causes of Growing Inequality
The demographics of the labor force in the
1970s and 1980s has also contributed to
the growing income inequality in those two
decades.
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A large number of “baby boomers” who were
less experienced and less skilled entered the
labor force at that time. Their incomes were
less than those of older workers.
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Causes of Growing Inequality
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Due to rising import demand, domestic
firms’ demand for less skilled workers
has decreased and this has reduced the
average wage for less skilled workers.
In addition, the transfer of jobs to lowwage workers in developing countries
has exerted downward pressure on
wages of less skilled workers in the U.S.
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Equality versus Efficiency
The Case for Equality: Maximizing Total
Utility
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An equal distribution of income maximizes the total
consumer satisfaction (or utility) for any particular
level of output and income.
The Case for Inequality: Incentives and
Efficiency
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Income distribution is important in determining the
amount of output or income that is produced and
available for distribution.
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The EqualityEfficiency Tradeoff
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The equality-efficiency tradeoff is the
decrease in economic efficiency that may
accompany an increase in income
equality.
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Greater income equality (achieved through
income redistribution) comes at the
opportunity cost of reduced production and
income.
Greater production and income comes at the
expense of higher income inequality.
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The Economics of Poverty
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Poverty is a condition in which a person or
family does not have the means to satisfy
basic needs for food, clothing, shelter, and
transportation.
The poverty rate is the percentage of the
population with income below the official
poverty income levels established by the
Federal government.
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The Economics of Poverty
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In the U.S., poverty is disproportionately
borne by African-Americans, Hispanics,
children, foreign-born residents who are
not citizens, and families headed by
women.
Marriage and full-time, year-around work
are associated with low poverty rates.
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The Economics of Poverty
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The thresholds for defining poverty may
inadequately measure the true extent of
U.S. poverty.
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Metropolitan areas have higher costs of living
which means that the official poverty
thresholds may exclude millions of families
whose incomes are slightly above the poverty
level but inadequate to meet basic needs.
Using income to measure poverty understates
the standard of living of many of the poor.
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The U.S.
Income-Maintenance System
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A widely accepted goal of U.S. public
policy is to help those who have very low
income.
Income-maintenance programs are
designed to reduce poverty and consists
of two kinds of entitlement programs:
(1) social insurance
(2) public assistance
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The U.S.
Income-Maintenance System
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Entitlement programs guarantee
particular levels of transfer payments or
noncash benefits to all who fit the
programs’ criteria.
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Social Insurance Programs
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Social insurance programs partially
replace earnings that have been lost due
to retirement, disability, or temporary
unemployment.
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They are funded primarily through Federal
payroll taxes.
The main programs include Social Security,
unemployment compensation, and Medicare.
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Social Insurance Programs
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Social Security is a Federal pension program
that replaces part of the earnings lost when
workers retire, become disabled, or die.
Medicare is a Federal insurance program that
provides health insurance benefits to those 65
and older.
Unemployment compensation is a FederalState social insurance program that makes
income available to workers who are
unemployed.
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Public Assistance Programs
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Public assistance programs, or “welfare”,
provide benefits for those who are unable
to earn income because of permanent
handicaps or have no or very low income
and also have dependent children.
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These programs, which include “means tests”,
are financed out of general tax revenues and
are regarded as public charity.
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Public Assistance Programs
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Supplement Security Income (SSI) is a
Federal program that provides a uniform
nationwide minimum income for the aged, blind,
and disabled who do not qualify for benefits
under the Social Security program in the U.S..
Temporary Assistance for Needy Families
(TANF) is the basic welfare program for lowincome families in the U.S..
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Public Assistance Programs
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The food stamp program is a Federal program
that permits eligible low-income persons to
obtain vouchers that are usable to buy food.
Medicaid is a Federal program that provides
medical benefits to people covered by SSI and
TANF.
The earned-income tax credit (EITC) is a
refundable Federal tax credit provided to lowincome wage earners to supplement their
families’ incomes and encourage work.
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