Who Gets What? The Distribution of Income

Ch. 11, p. 301-309

Describe the inequality in income and wealth in the U.S. and the world.

Explain why wealth inequality is greater than income inequality.

Explain how economic inequity arises.Explain poverty and its potential causes/effects.

Measuring economic equity and equality

• Equity—normative concept of fairness in distribution of wealth and income• Customs, laws, traditions to help disadvantages members of

society• Equity in income distribution is interpreted as greater equality

• Equality—spreading wealth and income equally, regardless of position or income in society• May or may not be equitable

• We measure economic inequality by looking at the distributions of income and wealth• Household’s income is the amount that it receives in a given

period• Household’s wealth is the value of the things it owns in a point

in time

Fairness and Equality

• Most Americans see fairness as equality of opportunity

• There are great differences of opinion as to what constitutes “equal opportunity”

• There are three problems in determining whether an equal income distribution is fair:

1. People do not start from equivalent positions

2. People’s needs differ

3. People’s efforts differ

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Economic statements

• “There is nothing wrong with a society where people starve alongside the extremely rich.”• Doesn’t this show that the problem of who gets what,

is solved by society?

• “The rich should pay more for university education.”

• “It is economically more efficient to increase output rather than redistribute it.”

What do you think?

Ways of Considering the Distribution of Income

• Share distribution of income is the relative division of total income among income groups

• Socioeconomic distribution of income is the allocation of income among relevant socioeconomic groups

• For example, it measures how much income the top 5% or 15%, or the bottom 10% gets

• For example, how much do women get compared to men, old compared to young, black compared to white

Quick review• Remember that in a market economy, the amount of g/s households

receive depends on their income; income is based on payments received by selling the FoP they own

• Output and income in a market economy depend on how many resource consumers (households) own and are able to sell in resource markets, as well as on the prices of the FoP sold.

• The problem of income distribution then is that ownership of FoP is highly unequal, and because prices determined of FoP vary enormously in the market

• Markets cannot ensure that everyone in population will secure enough income to satisfy their basic needs (a disadvantage of the market system).• Redistribution of income happens when governments use a

variety of methods to change market-determined distribution of income and output (to achieve a more socially desirable one).

The Lorenz Curve• A Lorenz curve is a geometric representation of the share distribution of income among families in a given country at a given time

• measures the cumulative percentage of total income on the Y axis and cumulative percentage of all wage earners on the X axis

• both axes start at zero and end at 100%

• 45 degree line is line of perfect equality (1% of income goes to 1% of wage earners…)

• The curve, then, shows uneven income distribution

• Further away from the 45 line, the more inequality exists

• This is measured in quintiles (20% portion of the population; Q1-Q5)

• Can also be measured in deciles (10%) or quartiles (25%)

Lorenz CurveLorenz Curve

% of National Income

Percentage of Population

This line represents the situation if income was distributed equally. The poorest 10% would earn 10% of national income, the poorest 30% would earn 30% of national income.

10%

10%

30%

30%

Gini CoefficientGini Coefficient

% of National Income

Percentage of Population

The total area under the line of equality

The area bounded by the Lorenz Curve

•Enables more precise Enables more precise comparison of Lorenz Curvescomparison of Lorenz Curves

•The proportion of the area The proportion of the area taken up by the Lorenz Curve taken up by the Lorenz Curve in relation to the overall area in relation to the overall area under the line of equalityunder the line of equality

The Gini CoefficientThe Gini Coefficient

ProsPros

• Generally regarded as gold Generally regarded as gold standard in economic workstandard in economic work

• Incorporates all dataIncorporates all data

• Allows direct comparison Allows direct comparison between units with different between units with different size populationssize populations

• Attractive intuitive Attractive intuitive interpretationinterpretation

ConsCons

• Requires comprehensive Requires comprehensive individual level dataindividual level data

• Requires more sophisticated Requires more sophisticated computationscomputations

Twice the area between the Lorenz curve and the equality Twice the area between the Lorenz curve and the equality diagonal.diagonal.

A Hypothetical Lorenz A Hypothetical Lorenz CurveCurve

The data in (a) were used to derive the Lorenz curve in (b). The The data in (a) were used to derive the Lorenz curve in (b). The Lorenz curve shows the cumulative percentage of income earned by Lorenz curve shows the cumulative percentage of income earned by the cumulative percentage of households. If all households received the cumulative percentage of households. If all households received the same percentage of total income, the Lorenz curve would be the the same percentage of total income, the Lorenz curve would be the line of perfect income equality. The bowed Lorenz curve shows an line of perfect income equality. The bowed Lorenz curve shows an unequal distribution of income. The more bowed the Lorenz curve is, unequal distribution of income. The more bowed the Lorenz curve is, the more unequal the distribution of income.the more unequal the distribution of income.

Cumulative % of income

20

Cumulative % of Families

60

80

100

40

20 60 80 100400

The Lorenz CurveA Lorenz Curve for the U.S., 1929, 1970, and 2007

Line of absolute equality

From 1929 to 1970,

income inequality decreased

From 1970 to 2007,

income inequality increased2007

1970

1929

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1010 2020 3030 4040 5050 6060 7070 8080 9090 100100

100100

9090

8080

7070

6060

5050

4040

3030

2020

1010

Cumulative Global Population

Cum

ulat

ive

Wea

lth (

PP

P)

World distribution of wealth Lorenz Curve

Pop’Pop’WealthWealth(PPP)(PPP)

   19881988 19931993

00 00 00

1010 0.90.9 0.80.8

2020 2.32.3 22

5050 9.69.6 8.58.5

7575 25.925.9 22.322.3

8585 4141 37.137.1

9090 53.153.1 49.249.2

9595 69.869.8 66.366.3

9999 91.791.7 91.591.5

100100 100100 100100

Line

of to

tal i

nteg

ratio

n

The richest 10% possessed

46.9% of the world wealth in

1988.

1010 2020 3030 4040 5050 6060 7070 8080 9090

100100

9090

8080

7070

6060

5050

4040

3030

2020

1010

Cumulative Global Population

Cum

ulat

ive

Wea

lth (

PP

P)

Calculating the Gini Coefficient

A

B

Although the Lorenz Curve is good visual indicator of distribution equality, the Gini Coefficient provides a clearer quantatitive value.

A / B = GiniValues should lie between 0 (total integration) to 1 (total segregation).Lin

e of

tota

l int

egra

tion

Defining Poverty

• Poverty can be defined as a relative or absolute concept

• The U.S. government definition of poverty is a combination of a relative and an absolute measure

• The poverty threshold is the income below which a family is considered to live in poverty

• Equal to or less than three times an average family’s USDA-calculated minimum food expenditures

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The Distribution of Wealth

• Wealth is the value of assets individuals own less the value of what they owe

• It is a stock concept representing the value of assets such as houses, buildings, and machines

• Income is payments received plus or minus changes in value of a person’s assets in a specified time period

• It is a flow concept, a stream through time

• In the U.S., wealth is significantly more unequally distributed than is income

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Cumulative % of income

20

Cumulative % of Families

60

80

100

40

20 60 80 100400

The Distribution of Wealth

Wealth Quintile

% of Total Household Wealth

Lowest 1/5 0.0

Second1/5 0.2

Third 1/5 3.8

Fourth 1/5 11.3

Highest 1/5 84.7

The distribution of wealth and wealth compared to income

Line of absolute equality

Family Income

Household Wealth

20-17

Occupational Category Male ($) Female ($)

Management 72,949 52,510

Business and Financial 64,965 46,974

Health Care Support 24,323 35,719

Food Preparation 18,060 19,060

Sales 48,392 30,777

Socioeconomic Dimensions of Income Inequality

Median Income

Year Male ($) Female ($)

1980 15,340 6,772

1990 27,866 19,816

2000 39,792 29,334

2007 45,113 35,102

Race, 2007 Median Income ($)

Asian 66,103

White 54,920

Black 33,916

Hispanic Origin 38,679

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Income Distribution According to Class

The class system as a pyramid, a diamond, and a pentagon

A developing country’s class system

U.S. class system in the 1960s and 1970s

U.S. class system in recent years

Upper

class

Upper class Upper

class

Middle class

Lower class

Middle class

Lower class

Middle class

Lower class

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Distributional Questions and Tensions in Society

• Both radicals and libertarians describe the tensions among classes in society better than the mainstream, classless analysis

• Mainstream economists focus on the share distribution of income

• Radicals focus on class and group structures

• Libertarians emphasize the role of special interests in shaping government policy

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Three Important Side Effects of Redistributive Programs

• Society may decide to redistribute income from rich to poor to meet its ideal of fairness

• There are three side effects of redistribution of income:• The labor to leisure incentive effect• The tax avoidance or evasion incentive effect• The incentive to appear more needy than you

actually are

• Often politics, not value judgments, plays a central role in determining what taxes and individual will pay

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Taxation to Redistribute Income

• A progressive tax is a one in which the average tax rate increases with income

• It redistributes income from the rich to the poor

• A regressive tax is a one in which the average tax rate decreases as income increases

• It redistributes income from poor to rich

• A proportional tax is a one in which the average tax rate is constant regardless of income

• It is neutral in regard to income redistribution

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Expenditure Programs to Redistribute Income

• Social Security is a social insurance program that provides financial benefits to the elderly and disabled and to their eligible dependents and/or survivors

• Medicareis a medical insurance system for retired people

• Expenditure programs have been more successful than taxation for redistributing income

Examples of expenditure programs:

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Distribution of Income before and after Taxes and Transfers

Cumulative % of income

20

Cumulative % of Families

60

80

100

40

20 60 80 100400

Line of absolute equality

Before taxes and transfers

After taxes and transfers

Although little redistribution takes place through the tax

system, more occurs through the transfer system

The after-tax and transfer distribution of income is more equal than the

before-tax-and-transfer distribution of income

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