Income Inequality, Poverty, and Discrimination

Chapter 20

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Objectives

• Income inequality in the U.S. • Sources of income inequality• Income inequality since 1970• Economic arguments regarding

income inequality• Poverty measurement and

incidence• The U.S. income-maintenance

program• Labor market discrimination

20-2

Facts About Income Inequality

• Average household income–$66,570 in 2006

–Among highest in the world

• Distribution by quintiles

• Income mobility–People change quintiles

• Government redistribution–Taxes and transfers 20-3

Facts About Income Inequality

(1)Quintile

(2)Percentage ofTotal Income

Lowest 20%

Second 20%

Third 20%

Fourth 20%

Highest 20%

Total

Distribution by Quintiles, 2006

3.4

8.6

14.5

22.9

50.5

100.0

Source: Bureau of the Census

(3)Upper

Income Limit

$20,035

37,774

60,000

97,032

No Limit

20-4

Income Inequality

• Lorenz Curve and Gini Ratio

20 40 60 80 100

20

40

60

80

100

0

Perfect Equality

Lorenz Curve(Actual Distribution)

Complete Inequality

A B

ab

c

d

e

f

Gini Ratio =Area A

Area A + Area B

Percentage of Households

Per

cen

tag

e o

f In

co

me

20-5

Government Redistribution

20 40 60 80 100

20

40

60

80

100

0

Lorenz CurveBefore Taxes and

Transfers

Percentage of Households

Per

cen

tag

e o

f In

co

me

Lorenz CurveAfter Taxes and

Transfers

Impact of Government Taxes and Transfers20-6

Causes of Income Inequality

• Ability• Education and training• Discrimination• Preferences and risks• Unequal distribution of wealth• Market power• Luck, connections, and

misfortune

20-7

Income Inequality Over Time

• Rising income inequality since 1970

• Causes of growing inequality–Greater demand for highly skilled

workers–Demographic changes–International trade, immigration,

and decline in unionism

20-8

Income Inequality

ColumbiaBrazil

South AfricaGuatemala

MexicoUnited States

ItalyJapan

SwedenGermany

0 10 20 30 40 50

Source: United Nations, Human Development Report, 2007/2008

Percentage Total Income Received by Top One-Tenth of Receivers, Selected Nations 2007

20-9

Equality Versus Efficiency

• The case for equality –Maximizing total utility

• The case for inequality–Incentives and efficiency

• The equality-efficiency tradeoff

20-10

The Utility-Maximizing Distribution of Income

Anderson’s MarginalUtility From Income

Brooks’ MarginalUtility From Income

0 0M

arg

inal

Uti

lity

Mar

gin

al U

tilit

y

Income Income

$5000 $5000$2500 $7500

MUBMUA

a

a’ b’

b

Utility Gain(Entire Blue Area)

Utility Loss(Entire Red Area)

Equality Versus Efficiency

20-11

The Economics of Poverty

• Definition of poverty 2006–Single person < $9,800–Family of 4 < $20,000–Family of 6 < $26,800–36.5 million Americans–Poverty rate 12.3%

20-12

Incidence of Poverty

Female HouseholdersAfrican Americans

HispanicsForeign-Born (Not Citizens)

Children Under 18Women

Total PopulationAsiansWhites

MenPersons 65 or Over

Married-Couple FamiliesFull-Time Workers

0 10 20 30

Poverty Rates Among Selected Population Groups, 2006

Source: Bureau of the Census, www.census.gov20-13

The Economics of Poverty

• Poverty rate trends–Significant decline 1959-1969–Stable in 11-13% range since–Rises with recession

• Measurement issues–Arbitrary threshold–Consumption vs. income

20-14

Income-Maintenance System

• Entitlement programs–All those eligible receive aid

• Social insurance programs–Social security and Medicare–Unemployment compensation

• Public assistance programs–Welfare

20-15

Public Assistance Programs

• Supplemental security income• Temporary assistance for needy

families• Food stamp program• Medicaid• Earned Income Tax Credit

20-16

Discrimination

• Inferior treatment• Taste-for-discrimination model

–Prejudice people receive disutility–Willing to pay to avoid–Discrimination coefficient–Prejudice and the market African-

American-White wage ratio–Competition and discrimination

20-17

Taste for Discrimination Model

Afr

ican

-Am

eric

an W

age

Rat

e(D

oll

ars)

African-American Employment (Millions)

0

D3

D2

D1

S

12 16 18

6

$98

MoreDiscrimination

LessDiscrimination

20-18

Discrimination

• Statistical discrimination–Judged on average group

characteristics

–Labor market example

–Profitable, undesirable, but not malicious

20-19

Discrimination

• Occupational segregation–The crowding model–Crowd certain groups into less

desirable occupations–Effects of crowding–Elimination of crowding

Discrimination

20-20

Occupational Segregation

Wag

e R

ate

B BBM M

W

3 4 3 4 64

Dx Dy Dz

Occupation X Occupation Y Occupation Z

Quantity of Labor(Millions)

Quantity of Labor(Millions)

Quantity of Labor(Millions)

By crowding women into one occupation (Z)…

Men enjoy higher wages in the other occupations (X and Y)

000

20-21

U.S. Family Wealth

Median and Average Family Wealth, 1995-2004 In 2004 Dollars

Year Median Average

1995199820012004

$70,80083,10091,70093,100

$260,800327,500421,500448,200

• Family wealth rose rapidly between 1995 and 2004

20-22

• Family wealth became more unequal between 1995 and 2004

Percentage of Total Family Wealth Held by Different

Percentile Groups, 1995-2004

1995199820012004

32.2%31.430.230.5

34.6%33.932.733.4

Year Bottom 90% Top 1%Bottom 10%

Percentile of Wealth Distribution

67.8%68.669.869.5

U.S. Family Wealth

20-23

Key Terms• income inequality

• Lorenz curve

• Gini ratio

• income mobility

• noncash transfers

• equality-efficiency trade-off

• poverty rate

• entitlement programs

• social insurance programs

• Social Security

• Medicare

• Unemployment compensation

• public assistance programs

• Supplemental Security Income (SSI)

• Temporary Assistance for Needy Families (TANF)

• food-stamp program

• Medicaid

• earned-income tax credit

• Discrimination (EITC)

• taste for discrimination model

• discrimination coefficient

• statistical discrimination

• occupational segregation 20-24

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20-25