Micro Ch20 Lecnotes

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PowerPoint Lecture Notes for Chapter 20: Income Inequality and Poverty

Pri nciples of Microeconomics4th

edition, by N. Gregory Mankiw

PowerPoint Slides by Ron Cronovich

2007 Thomson South-Western, all rights reserved

N . G R E G O R Y M A N K I W

PowerPointSlidesby Ron Cronovich

20

P R I N C I P L E S O F

F O U R T H E D I T I O N

MICROECONOMICS

Income Inequality and PovertyIncome Inequality and Poverty

This is the third of three chapters on the economics of labor markets. InChapter 18, students learned that equilibrium wages equal the value ofthe marginal product of labor. In Chapter 19, students learned aboutvarious factors that affect equilibrium wages, as well as discrimination.

In Chapter 20, students will learn about the extent of inequality andpoverty in the U.S. The chapter also introduces some of the leadingpolitical philosophies on the role of government in redistributingincome. Finally, the chapter discusses some policies designed to helpthe poor.

This chapter is shorter than average. Most students find it less difficultthan average. Therefore, most instructors are able to cover it in 60-75minutes of class time.

CHAPTER 20 INCOME INEQUALITY AND POVERTY 1

In this chapter, look for the answers to

these questions:

How much inequality and poverty exist i n our

society?

What are the problems measuring inequality?

What are some of the leading philosophies

on the proper role of government in altering

the distribution of income?

What policies are used to fight poverty? What are

the problems with these policies?


Introduction

Recap of the previous two chapters:

equilibrium wages equal the value of workersmarginal products

differences in equilibrium wages result from

differences in

worker characteristics:education, experience, talent, effort

job characteristics:extent to which a job is pleasant and safe

some earnings differences due to discrimination


Introduction

Even in the absence of discrimination,

the income distribution in a market economy

may not be equitable or otherwise desirable.

In this chapter, we examine

indicators of inequality and poverty

philosophies about income redistribution

policies designed to help the poor


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The U.S. Income Distribution: 2003

$170,082 and overTop 5 percent

$98,200 and overTop fifth

$65,000 $98,200Fourth fifth

$42,057 $65,000Middle fifth

$24,117 $42,057Second fifth

Under $24,117Bottom fifth

Annual family incomeGroup

Source: Table 1, Chapter 20.Original source: U.S. Bureau of the Census.


U.S. Inequality Over Time

4

6

8

10

12

14

1930

1940

1950

1960

1970

1980

1990

2000

Income share of the top 20 % dividedby income share of the bottom 20%

Income share of the top 20% dividedby income share of the b ottom 20%

Each point is the ratio of two numbers:The share of U.S. income received by the top 20%, relative to the shareof U.S. income received by the bottom 20%.

As the graph shows, this indicator of inequality fell from the GreatDepression until 1970, and then rose.



Inequality Around the World

0 5 10 15 20 25 30 35

Japan

Germany

India

Canada

United Kingdom

United States

Russia

China

Nigeria

Mexico

Brazil

South Africa

Income share of the top 20% dividedby income share of the bottom 20%

Income share of the top 20% dividedby income share of the b ottom 20%

At least for this sample of countries, the U.S. is roughly in the middlewith respect to inequality.

Source: Table 3, Chapter 20.Original source: World Development Report, 2005


Poverty

Poverty line: an absolute level of income

set by the govt for each family size

below which a family is deemed to be in poverty

Poverty rate: the percentage of the population

whose family income falls below the poverty line

In 2003 in the U.S.,

median family income = $52,680

poverty line for family of four = $18,810

poverty rate = 12.5%


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U.S. Poverty Over Time

Percent of the populationbelow poverty line

Percent of the populationbelow poverty line

The poverty rate appears correlated with business cycles. For example,1992-2000 was the longest economic expansion on record, and itcoincided with a gradual fall in the poverty rate. In the early 2000s, theU.S. experienced a recession, and the poverty rate rose.

Source: Figure 1, Chapter 20.Original source: U.S. Bureau of the Census.


U.S. Poverty Rate by Group, 2003

28.0Female household,

no spouse present

5.4Married-couple families

10.2Elderly

17.6Children

11.8Asian, Pacific Islander

22.5Hispanic

24.4Black

8.2White, not Hispanic

12.5%All persons

Poverty RateGroup



Problems Measuring Inequality

1. In-kind transfers: assistance that takes the form

of g&s rather than cash

Omitted from measures of inequality and poverty,

biasing them upward

2. The Life Cycle: the regular pattern of

income variation over a persons life

People can borrow and save to offset life-cycle

changes in income (e.g., saving for retirement). Life-cycle income variation causes inequality in

income, but not inequality in living standards.


Problems Measuring Inequality

3. Transitory vs. Permanent Income:

People can borrow and save to smooth out

transitoryincome fluctuations.

A better measure of inequality in living standardswould be based not on current income, but on

permanent income, a persons normal income.

4. Economic mobility:

Many people move among income classes.

The poverty and inequality measures

discussed above do not disti nguish between

the temporarily poor and the persistently poor.


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The Political Philosophy ofRedistributing Income

We consider three philosophies:

Utilitarianism

Liberalism

Libertarianism


Utilitarianism

Utility: a measure of happiness or satisfaction

Utilitarianism: argues that govt should choose

policies to maximize societys total utility

Founders: Jeremy Bentham, John Stuart Mill

Because ofdiminishing marginal utility,

redistributing income from rich to poor

increases utility of the poor more than it reduces

utility of the rich.

Yet, utilitarians do not advocate equalizing

incomes would reduce total income of everyone

due to incentive effects and efficiency losses.


Liberalism

Liberalism: argues that govt should choose

policies deemed to be just by an i mpartial observer

behind a veil of ignorance

Founder: John Rawls

Maximin criterion: govt should aim to maximize

the well-being of societys worst-off person

Calls for more redistribution than utilitarianism

(though still not complete equalization of incomes). Income redistribution is a form ofsocial insurance,

a govt policy aimed at protecting people against the

risk of adverse events.


Libertarianism

Libertarianism: argues that govt should punishcrimes and enforce voluntary agreements but notredistribute income

Advocate: Robert Nozick

Instead of focusing on outcomes, libertarians focuson the process.

Govt should enforce individual rights,

should try to equalize opportunities.

If the income distribution is achieved fairly,govt should not interfere, even if unequal.


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Policies to Reduce Poverty

Poor families more likely to experience

homelessness

drug dependence

health problems

teen pregnancy

illiteracy

unemployment

Most people believe govt should provide asafety net.

We now consider a few such policies


1. Minimum-Wage Laws

Arguments for:

helps the poor without any cost to the govt

little impact on employment if demand for

unskilled labor is relatively inelastic

Arguments against:

In the long run, demand for unskilled labor is

likely elastic, so minimum wage causes

substantial unemployment among the unskilled.

Those helped by minimum wage are more likely

to be teens from middle-income families than

low-income adult workers.

Students will recall the effects of the minimum wage from Chapter 6,which covered price floors and ceilings.

A few additional notes about the minimum wage:

Yes, it helps the poor at no cost to the government. But theres no suchthing as a free lunch. The minimum wage transfers income to workersfrom firms (or rather, their owners) and from consumers, who will endup paying higher prices for goods made with unskilled labor.

Some people think of the minimum wage as a law that prohibits peoplefrom working if they arent able to find a job that pays at least $5.15 anhour.


2. Welfare

Welfare: govt programs that supplement the

incomes of the needy

Temporary Assistance for Needy Families (TANF) Supplemental Security Income (SSI)

Critics argue that such programs create incentives

to become or remain needy, argue that welfarecontributed to the rise of t he single-parent family.

However, the severity of such incentive problems

is unknown.

Proponents note that inflation-adjusted welfare

benefits fell as single-parent families increased.


3. Negative Income Tax

Negative income tax: a tax system that collects

revenue from high-income households and gives

transfers to low-income households

Example: Taxes owed = (1/3 of income) $10,000

If earnings = $90,000, taxes o wed = $20,000

If earnings = $60,000, taxes o wed = $10,000

If earnings = $30,000, taxes o wed = $0

If earnings = $15,000, taxes owed = $5,000

i.e., would receive $5000 payment from govt

The Earned Income Tax Credit (EITC) is similar to a

negative income tax.

With a negative income tax, the marginal tax rate is as low for lowincome persons as it is for high income persons. This is in sharpcontrast to other welfare-type programs, which take away benefits asincome rises, thus creating very high effective marginal tax rates.


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4. In-Kind Transfers

In-kind transfers are goods or services provided to

the needy. Examples:

homeless shelters

soup kitchens

food stamps, govt vouchers redeemable

for food at grocery stores

Medicaid, govt-provided healthcare for the poor

An alternative: cash payments

would allow people to buy what they mos t need

but critics argue could be used for dr ugs, alcohol

A cash payment would let workers buy whatever they think they mostneed. Many economists believe that the government cannot know whatpeople need better than the people themselves.

Regarding the argument that the recipients could spend the money ondrugs:

Suppose the choice is giving the person $50 cash or $50 worth of food.If you give them $50 cash, they could buy drugs. If you give them $50worth of food, then they have $50 that would otherwise have been usedto buy food which they can now use to buy drugs.


Anti-Poverty Programs and Work Incentives

Assistance from anti-poverty programs

declines as income rises.

The result: Poor families face high effective

marginal tax rates (exceeding even 100% in

some cases!).

Such policies therefore discourage the poor from

escaping poverty on their own.

One possible solution: workfare, a systemrequiring people to accept government jobs

while collecting benefits.


CONCLUSION

Poverty is one of societys most serious problems.

One of the Ten Principles from Chapter 1:

Governments can sometimes

improve market outcomes.

Public policy can help reduce poverty and

inequality.

Another principle: people face trade-offs.

Policies designed to improve equityoften sacrifice efficiency, so the proper scope of

policy is the subject of ongoing controversy.


CHAPTER SUMMARY

Data on income distribution show a wide disparity

in our society. The richest 20% of families earn

about ten times as much as the poorest 20%.

Problems in measuring inequality arise from

in-kind transfers, the economic life cycle,

transitory income, and economic mobility.

When these factors are taken into account,the distribution of well-being is probably less

unequal than the distribution of annual income.


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CHAPTER SUMMARY

Political philosophers differ in their views of the

proper role of government in altering the income

distribution. Uti litarians believe that income

distribution should maximize the sum of

everyones utility. Liberals believe the government

should aim to maximize the well-being of the

worst-off person in society. Libertarians believe

the government should aim for equality of

opportunity, not equality of income.


CHAPTER SUMMARY

Policies such as welfare, minimum-wage laws,

negative income taxes, and in-kind transfers can

help the poor.

Since financial assistance falls as income rises,

the poor face high effective marginal tax rates,

discouraging them from escaping poverty on theirown.

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Micro Ch20 Lecnotes