INCOME INEQUALITY AND POVERTY

INCOME INEQUALITY AND POVERTY

❖ A person's earnings depend on the

supply and demand for that person's labor,
which in turn depend on natural ability,
human capital, compensating differentials,
discrimination, and so on.

THE MEASUREMENT OF INEQUALITY

➢ How much inequality is there in our

society?

➢ How many people live in poverty?

➢ What problems arise in measuring the

amount of inequality?
 ➢ How often do people move among
income classes?

Table 1: The Distribution of Income in the

United States: 2000
U.S. INCOME INEQUALITY

•Imagine that you...

➢ lined up all of the families in the

economy according to their annual
income.

➢ divided the families into five equal

groups (bottom fifth, second fifth, etc.)

➢ computed the share of total income

that each group of families received.

Table 2: Income Inequality in the United

States
 ❖ If income were equally distributed
across all families, each one-fifth of families
would receive one-fifth (20 percent) of total
income.

❖ From 1935-1970, the distribution of

income gradually became more equal.

❖ In more recent years, this trend has

reversed itself.

•Reasons for Recent Increase in Income

Inequality

● The following have tended to reduce the

demand for unskilled labor and raise the
demand for skilled labor:
 ● Increases in international trade with low-
wage countries

● Changes in technology

● Therefore, the wages of unskilled

workers have fallen relative to the wages
of skilled workers.

● This has resulted in increased inequality

in family incomes.

CASE STUDY :The Women's Movement and

the Income Distribution

❖ The percentage of women who hold jobs

has risen from about 32 percent in the 1950s
to about 54 percent in the 1990s.
CASE STUDY: Income Equality around the
world
THE POVERTY RATES
❖ The poverty rate is the percentage of the
population whose family income falls below
an absolute level called the poverty line.

PROBLEMS IN MEASURING
INEQUALITY

The Poverty Line

❖ The poverty line is an absolute level of

income set by the federal government for
each family size below which a family is
deemed to be in poverty.
•The Poverty Line and Income Inequality

➢ As economic growth pushes the

entire income distribution upward, more
families are pushed above the poverty
line because the poverty line is an
absolute rather than a relative standard.

➢ Despite continued economic growth

in average income, the poverty rate has
not declined.

➢ Although economic growth has

raised the income of the typical family,
the increase in inequality has prevented
 the poorest families from sharing in this
greater economic prosperity.

• THREE FACTS ABOUT POVERTY

➢ Poverty is correlated with race.

➢ Poverty is correlated with age.

 ➢ Poverty is correlated with family
composition.
• Data on income distribution and the
poverty rate give an incomplete picture of
inequality in living standards because of the
following:

➢ In-kind transfers

➢ Life cycle

➢ Transitory versus permanent income

•In-Kind Transfers

➢ Transfers to the poor given in the

form of goods and services rather than
cash are called in-kind transfers.
 ➢ Measurements of the distribution of
income and the poverty rate are based on
families' money income.

➢ The failure to include in-kind

transfers as part of income greatly
affects the measured poverty rate.

•The Economic Life Cycle

● The regular pattern of income variation over

a person's life is called the life cycle.

➢ A young worker has a low

income at the beginning of his or her
career.

➢ Income rises as the worker gains

maturity and experience.
 ➢ Income peaks at about age 50.

➢ Income falls sharply at

retirement, around age 65.

•Transitory versus Permanent Income

● Incomes vary because of random and

transitory forces.

➢ Acts of nature

➢ Temporary layoffs due to illness

or economic conditions, etc.

➢ A family's ability to buy goods

and services depends largely on its
permanent income, which is its
normal, or average, income.
 ➢ Permanent income excludes
transitory changes in income.

ECONOMICS MOBILITY

➢ The movement of people among

income classes is called economic
mobility.

➢ Economic mobility is substantial in

the U.S. economy.

● Movements up and down the income ladder

can be due to:

➢ Good or bad luck.

➢ Hard work or laziness.

 ➢ Persistence of economic success
from generation to generation.

POLITICAL PHILOSOPHY OF
REDISTRIBUTING INCOME

• What should the government do about

economic inequality?

➔ Economic analysis alone cannot give us

the answer.

➔ The question is a normative one facing

policymakers.

•THREE POLITICAL PHILOSOPHIES

 ● Utilitarianism

● Liberalism

● Libertarianism
UTILITARIANISM

➢ Utilitarianism is the political philosophy

according to which the government should
choose policies to maximize the total utility
of everyone in society.

➢ The founders of utilitarianism are the

English philosophers Jeremy Bentham and
John Stuart Mill.

➢ The utilitarian case for redistributing

income is based on the assumption of
diminishing marginal utility.
 ➢ An extra dollar of income to a poor
person provides that person with more
utility, or well- being, than does an extra
dollar to a rich person.

LIBERALISM

➢ Liberalism is the political philosophy

according to which the government should
choose policies deemed to be just, as
evaluated by an impartial observer behind a
"veil of ignorance."

➢ This view was originally developed by

the philosopher John Rawls.

➢ Public policy should be based on the

maximin criterion, which seeks to
maximize the utility or well-being of the
worst-off person in society.
 ➢ That is, rather than maximizing the sum
of everyone's utility, one should maximize
the minimum utility.

➢ This idea would allow for the

consideration of the redistribution of income
as a form of social insurance.

LIBERTARIANISM

➢ Libertarianism is the political philosophy

according to which the government should
punish crimes and enforce voluntary
agreements, but should not redistribute
income.

➢ Libertarians argue that equality of

opportunity is more important than equality
of income.
POLICIES TO REDUCE POVERTY

● Minimum-wage laws

● Welfare

● Negative income tax

● In-kind transfers

Minimum-Wage Laws

➢ Advocates view the minimum wage as a

way of helping the working poor.

➢ Critics view the minimum wage as

hurting those it is intended to help.
 ➢ The magnitude of the effects of the
minimum wage depends on the elasticity of
the demand for labor.

➢ Advocates argue that the demand for

unskilled labor is relatively inelastic, so that
a high minimum wage depresses
employment only slightly.

➢ Critics argue that labor demand is more

elastic, especially in the long run when firms
can adjust employment more fully.

WELFARE

➔ The government attempts to raise the

living standards of the poor through the
welfare system.
 ➔ Welfare is a broad term that
encompasses various government programs
that supplement the incomes of the needy.

➢ Temporary Assistance for Needy

Families (TANF)

➢ Supplemental Security Income (SSI)

NEGATIVE INCOME TAX

➢ A negative income tax collects tax

revenue from high-income households and
gives transfers to low-income households.
➢ High-income families would pay a tax
based on their incomes.

➢ Low-income families would receive a

subsidy -a "negative tax."
 ➢ Poor families would receive financial
assistance without having to demonstrate
need.

IN-KIND TRANSFERS

➢ In-kind transfers are transfers to the poor

given in the form of goods and services
rather than cash.

➢ Food stamps and Medicaid are

examples.

➢ Advocates of in-kind transfers argue that

such transfers ensure that the poor get what
they most need.
 ➢ Advocates of cash payments argue that
in-kind transfers are inefficient and
disrespectful.

ANTIPOVERTY PROGRAMS AND WORK

INCENTIVES

➢ Many policies aimed at helping the poor

can have the unintended effect of
discouraging the poor from escaping poverty
on their own.

•An antipoverty program can affect work

incentives:

➢ A family needs $15,000 to maintain a

reasonable standard of living.
 ➢ The government promises to guarantee
every family a $15,000 income.

➢ Any person making under $15,000 has

no incentive to work due to the effective
marginal tax rate of 100 percent.

➢ Workfare refers to a system that would

require any person collecting benefits to
accept a government-provided job.

➢ A 1996 welfare reform bill advocated

providing benefits for only a limited period
of time.

SUMMARY

• Data on the distribution of income show wide

disparity in our society.
• The richest fifth of the families earns about ten
times as much as the poorest fifth.

• It is difficult to gauge the degree of inequality

using data on the distribution of income in a
single year.
• Political philosophers differ in their views
about the role government should play in
redistributing income.

• Utilitarians would choose the distribution of

income to maximize the sum of the utility of
everyone in society.

• Liberals would determine the distribution of

income as if we were behind a "veil of
ignorance" that prevented us from knowing our
own stations in life.
• Libertarians would have the government
enforce individual rights but not be concerned
about inequality in the resulting distribution of
income.

• Various policies aimed to help the poor

include: minimum-wage laws, welfare, negative
income taxes, and in-kind transfers.

• Although each of these policies helps some

families escape poverty, they also have
unintended side effects.