Income Inequality & 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.
 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?
 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.
 The percentage of women who hold jobs has
risen from about 32 percent in the 1950s to
about 54 percent in the 1990s.
 The poverty rate is the percentage of the
population whose family income falls below
an absolute level called the poverty line.
 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.
Percent of the
Population
below Poverty
Line
25
20
Poverty rate
15
10
1960 1965 1970 1975 1980 1985 1990 1995 2000
Copyright©2003 Southwestern/Thomson Learning

 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.
Copyright©2004 South-Western
 Three Facts About Poverty
◦ Poverty is correlated with ethnicity.
◦ 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.
 The movement of people among income
classes is called economic mobility.
 Economic mobility is substantial in the
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.
 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 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 is the political philosophy
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 is the political philosophy
punish crimes and enforce voluntary
agreements, but should not redistribute
income.
 Libertarians argue that equality of
opportunity is more important than equality

of income.
 Minimum-wage laws
 Welfare
 Negative income tax
 In-kind transfers
 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.
 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)
◦ 4Ps
◦ Etc.
 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 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.
 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 Php15,000 to maintain a reasonable
standard of living.
◦ The government promises to guarantee every
family a Php15,000 income.
◦ Any person making under Php15,000 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.
 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.

Income Inequality & Poverty

Uploaded by

Copyright:

Available Formats

Income Inequality & Poverty

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Income Inequality & Poverty

Uploaded by

Copyright:

Available Formats

A person’s earnings depend on the supply and

demand for that person’s labor, which in turn

1960 1965 1970 1975 1980 1985 1990 1995 2000

Copyright©2003 Southwestern/Thomson Learning

philosophers Jeremy Bentham and John Stuart

philosopher John Rawls.

everyone’s utility, one should maximize the

the redistribution of income as a form of

opportunity is more important than equality

those it is intended to help.

elastic, especially in the long run when firms

various government programs that

assistance without having to demonstrate

kind transfers are inefficient and

ten times as much as the poorest fifth.

using data on the distribution of income in a

income to maximize the sum of the utility of

enforce individual rights but not be

families escape poverty, they also have

You might also like