Chapter 11: Income Inequality and Poverty

Chapter 11: Income Inequality and Poverty

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Facts about Income Inequality In 2003,

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 Income inequality is the unequal

distribution of an economy’s total income among households or families. 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 Curveand Gini Ratio

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 Curveand Gini Ratio

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 Curveand Gini Ratio

The Gini ratio is calculated as:Area between Lorenz curve and diagonal

Total area below the diagonal 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.

Gini ratio =

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Income Mobility:The Time Dimension

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 GovernmentRedistribution

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 The factors that contribute to income

inequality include: 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 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: 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. 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. 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 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 low-wage workers in developing countries has exerted downward pressure on wages of less skilled workers in the U.S.

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Equality versus EfficiencyThe Case for Equality: Maximizing Total Utility 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 Income distribution is important in determining the

amount of output or income that is produced and available for distribution.

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The Equality-Efficiency Tradeoff

The equality-efficiency tradeoff is the decrease in economic efficiency that may accompany an increase in income equality. 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 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 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 The thresholds for defining poverty may

inadequately measure the true extent of U.S. poverty. 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

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

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 Social insurance programs partially

replace earnings that have been lost due to retirement, disability, or temporary unemployment. 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 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 Federal-State social insurance program that makes income available to workers who are unemployed.

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Public Assistance Programs 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. 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 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 low-income families in the U.S..

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Public Assistance Programs 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 low-income wage earners to supplement their families’ incomes and encourage work.